Information About Business Law

Q. I am part of a small group of investors hat wants to start up our own business. How do we decide what type of legal entity is that the right way to go?


A. The choice of the right legal entity is complicated and depends on many different considerations, such as participation of owners in management, formality of Publishinggovernance, record keeping requirements, assumption of personal liability, taxation issues and flexibility, to name a few. There is no formula that you can just plug the information into and get the right answer. Your group should get together and decide what considerations are most important to you and, if possible, prioritize them. Your lawyer can then advise you on the best choice.


Q. A good friend from my church has invited me to join the business she has operated for 4 or 5 years. She wants me to be her partner and share expenses and profits 50/50. My initial investment would be pretty small and I like the business she is in, so I am interested. I trust her, but I wonder if I should put everything in writing.


A. Absolutely. Disagreements between business owners are almost inevitable, can all too frequently result in litigation and have destroyed countless friendships. Although verbal agreements are generally enforceable, they are often difficult to prove. Your initial investment represents your equity in the business and should be protected, if at all possible. Having a written agreement between the owners can help do that and, more importantly, will spell out the rights and obligations of each party to the business and to each other. Your attorney can prepare documents that will address the situations or issues that might arise in such business relationships and how disputes between the owners are to be handled.


Q. I have heard about partnerships and limited partnerships. What are the differences?


A. The term “partnership” typically refers to a general partnership. In a general partnership all of the partners are “general” partners, each partner can participate in the management of the enterprise and each partner has joint and several personal liability for the debts and obligations of the partnership. (Joint and several means that all the partners are equally liable but if the other partners can’t or don’t pay, you get it all). In a limited partnership there must be at least one general partner and one limited partner, only the general partner can participate in management of the partnership and the limited partner’s liability is limited -typically to the amount of their investment in the partnership. In both cases the partnership itself does not pay taxes, the profits (and losses) are passed through to the partners and they pay the taxes and the assets of the enterprise are technically owned by the partners rather than the partnership.


Q. A neighbor of mine just set up a “limited liability company” to buy some real estate he plans to develop. I have never heard of a limited liability company, what is it?


A. A limited liability company, often called an “LLC”, is a relatively new form of legal entity recognized in Texas and most other states. It is sort of a hybrid between a partnership and a corporation. The owners each have limited liability like the shareholder of a corporation, so their personal risk is limited to the amount of their investment in the company. They are called “members” rather than shareholders and they own “membership interests” rather than shares. Like the general partners of a partnership, each member can, if they choose, participate directly and fully in the management of the company. In most cases, LLC’s are treated as a partnership for tax purposes, so the profits (and losses) are passed through to the members, who pay the taxes. The governance and record keeping requirements are generally not as formal as a corporation but LLC’s are typically run more formally than partnerships. Like a corporation, the entity owns the assets; the individual members only own their membership interest. Because of the limited liability, ease of governance, favorable tax treatment and flexibility they offer, LLC’s are becoming more common and are often recommended to their clients by lawyers and CPA’s.


Q. My cousin just formed an “S” corporation for his business? How is that different from a regular corporation?


A. An “S” corporation is simply a corporation that has elected “pass-through” tax treatment under certain provisions of the Internal Revenue Code and has met the criteria under those provisions necessary to qualify for such tax treatment. For example, to qualify as an “S” corporation there can be no more than 75 shareholders, all of the shareholders must be natural persons (no partnerships, corporations or LLC’s) and U. S. citizens and there can be only one class of stock. The “S” corporation does not pay taxes on its profits; the profits (and losses) are passed through to the shareholders. In most other respects an “S” corporation is identical to a regular, or “C”, corporation.


Q. When my father started his business years ago he set it up as a corporation. My brother and I now own the business and we want to change the form of the legal entity. Can we do that?


A. There are several ways this can be accomplished. Most of the Texas statutes that relate to business organizations have provisions that allow one entity to be converted to another entity by the adoption of a plan of conversion and the filing of Articles of Conversion with the Secretary of State. However, there may be tax consequences to converting, so you should consult with your tax advisor. Another method would be to create a new entity in the form you desire and then merge the old corporation into the new entity. This method is more complicated and has some limitations, but it can be more flexible in the manner in which it is done and can often avoid any tax consequences. You should consult with your lawyer and tax advisor in either case.


Q. I know about income taxes and sales taxes, but what is a “margin tax”?


A. Texas, like most states, requires certain business organizations such as corporations, limited liability companies and limited partnerships to file papers with the State in order to be officially formed, recognized as existing and qualified to conduct business in the State. Once that is done, the organization may be required to pay an annual tax or fee, typically called a franchise tax, in order to maintain that official status. In most states the franchise tax is a predetermined amount, often established by statute, that the organization pays in exchange for the privilege of conducting business in that state. In Texas the franchise tax is really more like a corporate income tax because the amount required to be paid is based on the taxable income of the business organization. Corporations and limited liability companies are required to pay franchise tax in Texas, but partnerships generally are not. There are also minimum threshold levels of taxable income that must be reached before the franchise tax must be paid. Your legal or tax advisor can provide you with more details.


Q. I have been running the family business for almost 30 years and I am ready to retire. Unfortunately, I have no heirs to leave the business to and I don’t want to sell it to a stranger. The last few years have been just barely break-even and it looks like more of the same in the coming years, so I think now is a good time to just wrap it up. Everything is owned by the corporation and my wife and I are the only shareholders. What do I need to do?


A. There are many factors to consider, including estate planning and tax consequences. However, focusing just on the corporate aspects what you need to do is wind up the affairs of the corporation and dissolve it. Winding up the affairs means collecting and selling or otherwise disposing of the assets of the corporation (in most cases that means converting them to cash) and paying or satisfying all of the debts, obligations and liabilities of the corporation, including tax liabilities, or making adequate provision to do so. “Adequate provision” would include setting aside funds to cover any estimated future liabilities, settling or resolving any open disputes, claims or litigation and making sure that insurance coverage is in place and adequate to handle any other unliquidated claims. It is extremely important to do this, not just out of fairness to your creditors, but also to insure that you do not lose the limited liability protection of the corporate structure. After all of the debts, obligations and liabilities are paid, if there is cash or other assets remaining, they can be distributed out to the shareholders according to their interests. Note that if the assets are insufficient to discharge all of the liabilities, the corporation may have to seek protection under the bankruptcy laws. When all of this has been accomplished, then Articles of Dissolution can be filed with the Secretary of State and once the Comptroller of Public Accounts verifies that all tax liabilities to the state have been satisfied a Certificate of Dissolution will be issued.

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