S Corp. vs. LLC in Texas

By Tom Speranza, J.D.

S Corp. vs. LLC in Texas

By Tom Speranza, J.D.

The Texas Business Organizations Code (BOC) spells out the legal rights and obligations of various business entities recognized by the state of Texas, including corporations and limited liability companies (LLCs).

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An S corporation in Texas is a for-profit corporation that has elected S corporation status by filing the Election by a Small Business Corporation (Form 2553) with the U.S. Internal Revenue Service (IRS). An S corp. passes through its income, losses, credits, and deductions to its shareholders for federal tax purposes. The shareholders report such items on their individual federal tax returns and the corporation pays no federal income tax as a separate entity.

When forming a small business in Texas, many entrepreneurs consider both the S corporation and LLC structures but might not be familiar with how they differ.

Formation and Filing Fees

Generally speaking, the processes for establishing a corporation and establishing an LLC under the BOC are very similar. Each entity forms by filing a certificate of formation with the Texas Secretary of State and paying the applicable fee.

In addition to the required information (name, registered agent, duration, effective date), each entity must make disclosures relevant to its structure. Corporations cite their maximum number of authorized shares, their classes of stock (if any), and the names of their initial directors. LLCs state whether they will be member-managed or manager-managed and, depending on the management structure selected, list their initial members or initial managers (called "governing persons" under the BOC).

Limitations on S Corp. Ownership and Capital Structure

The most crucial difference between the two business entities is that federal law imposes certain limitations on the capital structure and ownership of S corporations:

  • An S corp. must have only one class of stock, but it can issue non-voting shares that are otherwise identical to the voting shares.
  • An S corp. can have no more than 100 shareholders, but spouses, certain family members, and their estates sometimes count as single shareholders for purposes of this limit.
  • All S corp. shareholders must either be individuals, estates, certain kinds of trusts, or entities that are exempt from federal income tax under Sections 401(a) or 501(c)(3) of the U.S. Tax Code.
  • No S corp. shareholder can be a nonresident alien.

An LLC, in contrast, is not subject to limitations relating to the number or types of membership interests it can issue or the number or nature of its members.

Limited Liability

Both S corporations and LLCs limit their owners' liability for the entity's debts and obligations. In other words, suppliers, customers, tax authorities, employees, contractors, and others making legal claims against the entities can only seek payment or damages from the entity and its assets. The personal assets of the S corporation's shareholders and LLC's members are not at risk.

The BOC also recognizes a relatively new business entity known as a "series LLC," which can issue different series or classes of membership interest, with each owning a designated portion of the LLC's assets. For liability purposes, the asset pools associated with each series have limited liability from one another. For example, this structure can be used in a real estate business in which each series owns a different property. With a series LLC, the creditors of one property cannot make claims or seek damages against the other properties owned by the LLC.

Texas law has not yet created a corporation that can segregate its assets into separate classes of stock.

Governance and Recordkeeping

As a general rule, corporations have more complicated governance and management structures than LLCs.

Corporation

Under the BOC (and virtually every other state's corporation law):

  • A corporation's shareholders must elect a board of directors consisting of at least one director.
  • The corporation's board must adopt a set of bylaws setting forth the rules of shareholder and director meetings, voting and approvals, and the titles and powers of the corporation's officers.
  • The board must appoint officers to hold the president, treasurer, and secretary titles.
  • Although an individual can be a sole shareholder, sole director, and the holder of the three required officer positions, a corporation must hold meetings of the shareholders and directors at least once annually, either in person or by written consent, and maintain the minutes and resolutions of such meetings.
  • Corporations must keep careful records of the shareholders' capital contributions, the stock certificates issued to them, and any transfers of shares.

Limited Liability Company

An LLC, in contrast, is owned by members who can decide to either manage the LLC themselves (a member-managed LLC) or vest such powers in managers who may or may not be members of the LLC (a manager-managed LLC). An LLC with or without managers can also delegate management duties to officers.

In Texas, LLCs adopt a company agreement, known as an "operating agreement" in most other states, that sets out the rules for member and manager decision-making and the process for electing and removing managers and officers, if any. Company agreements usually include restrictions on the members' right to transfer the LLC's membership interests.

LLCs in Texas have broad authority to structure their company agreements to fit their desired governance structure. The provisions of the company agreement overrule the default governance and voting rules contained in the BOC.

Taxation

For federal taxes, most LLCs and S corporations pass through their income and losses to the owners and do not pay federal income tax as separate entities, although an LLC has the option of electing to be taxed as a corporation.

Both S corporations and LLCs operating in Texas are subject to a margin tax applied to the entity's gross receipts generated in the state after deduction of employee compensation and the cost of goods sold.

A small-business owner should consult an accountant and an experienced corporate lawyer in Texas to determine whether an S corporation or LLC makes sense for their enterprise.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.