ORGANIZATION OF YOUR BUSINESS
Among the several decisions you must make before starting a new business is the form of business organization you wish to adopt. There are three basic forms to select from and the principal advantages and disadvantages of each are listed here:
Be aware that in a partnership, the partners are collectively and individually responsible for the indebtedness of the enterprise and that this liability is unlimited as in a proprietorship.
If you form a partnership, you may engage a qualified attorney to draft a partnership agreement that spells out the general wishes of the partners, but which also covers the many other items that are necessary to assure a more successful business enterprise. Buy a standard Partnership Agreement to do it yourself and adapt it for your own special needs. These forms are available in office supply stores.
To form a Corporation, you should secure the help of an attorney or business consultant to draft your charter, get state approval and to advise you regarding the state laws governing corporations with which you must comply. We can help you to incorporate your business. Our office number is 713-726-9972.
A Corporation offers the advantage of easy ownership transfer, unaffected by the death or transfer of stock shares by any or all owners and the owners (share holders) have limited liability for the indebtedness of the corporation. They may lose their original investment and no more, unless they sign personal guarantees or other such forms giving up this protection.
A corporation has less flexibility, is subject to more government rules and regulations and all profits are taxed twice.
In addition, to these three basic business forms described above, there are others that are recognized by certain states. Your lawyer can advise you about these depending on which state your business is located.
The Internal Revenue Service recognizes what is known as Chapter S Corporation. The principal advantage is that the corporation profits and/or losses flow directly to the shareowners as in a proprietorship rather than to the shareowners - as after tax dividends. Double taxation is thus avoided. Limited to 100 shareholders, percentage of profits must be passed through to stockholders. This is excellent for family ownership.
FORMS OF ORGANIZATION
Proprietorship
Advantages |
Disadvantages |
|
|
Partnership
(Limited or General Partnership)
Advantages |
Disadvantages |
|
|
Corporation
Advantages |
Disadvantages |
|
|
FACTORS TO BE CONSIDERED IN A PARTNERSHIP AGREEMENT
S CORPORATION
IRS Publication 589
In 1981, Congress increased the applicability of Chapter S; the tax and legal provision that lets closely held companies combine the best features of partnership and incorporation. Important as these changes were, further recent steps by Congress make S corporations even more attractive for small companies.
The Internal Revenue Service Code's Sub S Provision are designed for small, closely held businesses looking to incorporate for legal reasons while remaining partnerships for tax purposes. As before, businesses most apt to find S Corporations beneficial in light of the latest changes are start-up companies with anticipated early losses (which can be passed onto shareholders as tax deductions) and highly profitable companies with low capital spending needs and high dividend distributions.
Because the new rules widen eligibility requirements, eliminate some major tax traps, and substantially upgrade the permitted level of pension plan contributions, it is easier for businesses to be qualified for S corporation. Previously, for instance, businesses earning substantial income from passive investments couldn't elect for S corporation. While there are still restrictions, the new law clears the way for what amounts to S investment firms - companies not engaged in active trade or business at all.
However, non-capital intensive service concerns chose S corporation status for certain fringe benefits for S corporation shareholders of more than 2% of the company's stock will now be limited to the lower levels allowed for partnerships.
Under ERTA, the maximum number of shareholders permitted for Sub S companies was raised from 35 to 100. Significantly, the new law increases the maximum number of shareholders in an S corporation from 35 to 100, greatly increasing the ability of S companies to attract capital from new investors. The new law also eliminates a rule that ended a corporation's Sub S status if more than 80% of its gross receipts came from outside the United States.
One of the most important eligibility rules makes Sub S available from companies whose passive-investment income from such sources as stocks, bonds and rental property exceeds 20% of gross receipts for any taxable year. Under the old rules, S status ended if passive earnings exceeded 20% of gross revenues.
Congress didn't eliminate all restrictions for passive income. They have generally been eliminated except for those electing corporations that have earnings accumulated from pre- S tax periods.
For those electing corporations with S accumulated earnings, the rules have been substantially liberalized. But passive earnings in excess of 25% of gross receipts will be subject to normal federal corporate taxes at 46%. A company's S election will terminate only if the company's passive income exceeds 25% for three years in a row.
There are important exceptions, however. Unlike a company that has accumulated earnings when it elects S status, a newly formed corporation can operate under S status from the start and be exempt from the passive income limitation.
Generally, the new law allows S corporations to treat certain matters relating to income, deductions and credits, much as partners in partnerships do and not as shareholders in corporations do. For example, before, business losses in excess of shareholder basis (the total invested in stock and loans) couldn't be used as deductions past the fiscal year-end. For tax purposes, the losses were gone forever.
The new law allows losses to be carried forward by S corporation shareholders indefinitely if the amount of the loss passed through to shareholders during the year tops the shareholders' basis. Individual holders can deduct the loss carried forward as long as they provide new equity or loans to the corporation.
Under the old law, S status could be revoked if a company broke one of the several technical rules, even inadvertently. Having one too many shareholders, for instance, could invalidate a company’s S status. But now the Internal Revenue Service can waive the automatic termination.
For example, an ineligible shareholder, such as a financial institution in a foreclosure, assumes the assets of a previous S shareholder. Under the old law, such an event would have terminated the corporation's S status, although very possibly shareholders would have been unaware of the violation. Even if the violation were quickly corrected, that might not have been sufficient: The old law didn't recognize any change in status unless shareholders took the necessary steps to restore the S status.
In the past, the IRS came after S companies for back taxes as regular corporations from the years when they were in technical violation of S rules. But the statutory permissions from Congress to waive termination, eliminates many of the unexpected and costly consequences to S corporations.
As to pensions plans, the new rules permit S shareholders to contribute the same $30,000 maximum permitted for regular corporate plans.
Previously, S shareholders were restricted to contributions of $15,000 for self-employed persons, and for some, this was a deterrent to electing the S corporation. But when Congress passed the Tax Equity and Fiscal Responsibility Act of 1982, it created parity between the pension plans of corporations and those of self-employed persons and S shareholders.
Ultimately, all the new rules regarding S status may have limited impact on companies seeking to retain earnings for growth. But for closely held businesses with early-year losses, or those that are profitable and distribute their earnings as dividends, it is time for a new look at S corporations.
On August 26, 1991, the Texas Limited Liability Company Act became effective. The new form of legal entity created by the act will be considered by as an alternative to an S corporation or a limited partnership, because of its ability to combine the favorable tax treatment of partnerships with the limited liability of corporations.
The limited liability company is not subject to any of the burdensome restrictions imposed upon S corporations such as restrictions on the number of shareholders, restrictions on more than one class of stock and, on the percentage, ownership of stock of other corporations.
Use of a limited liability company will also provide your customer with certain tax advantages over the S corporation. Because properly structured limited liability companies are taxed as partnerships, owners of the company can include their respective shares of the liabilities incurred by the limited liability company in the basis of their ownership interests for purposes of determining the deductibility of losses allocated to them. Moreover, upon a sale or exchange of an interest in a limited liability company (or upon a death of a member), the transferee can obtain the benefit of an adjustment to the basis of the interest acquired. No such basis adjustments are available to S corporations.
While the limited liability company and a limited partnership enjoy the same tax benefits, use of this entity will provide other benefits not available to a limited partnership or only available at the cost of considerable complexity. In a limited partnership, any limited partners who materially participate in the management of the partnership runs the risk of losing his limited liability. For operational purposes, each limited partnership must have at least one general partner who has unrestricted liability for the partnership’s debts. If you attempt to overcome the unlimited liability of the managing partner by using a thinly capitalized corporation which is contracted by the limited partners an s manager, you jeopardize the classification of the entity as a partnership. A limited liability company ("LLC") may be established to engage in practically any business for which a corporation could be incorporated in the state of Texas. Two or more persons or entities filing articles of organization in the office of the Secretary of State in Austin form the LLC. While similar to Articles of Incorporation filed to form a Texas corporation. Articles of Organization are required to state a period of duration for the life of the LLC, which cannot exceed the maximum term of thirty years. Owners of an LLC may adopt "regulations" for its operation similar to corporate bylaws, which may vary the provisions of the Act with respect to the LLC's internal operations.
The LLC equivalent to the corporate shareholder or limited partner is called a member. There are virtually no restrictions on the types of persons or entities who may be members of an LLC. Unlike the S corporation, an LLC may have different classifications of membership, which may accommodate any arrangement for the allocation of profits and losses.
A member may sell, pledge, or otherwise transfer his or her interest in an LLC. Note, however, that a member may not transfer his or her entire interest in an LLC without the consent of all other members unless the LLC's regulations so permit.
While the LLC will ordinarily be managed and operated like a corporate entity, the members, if they so desire, may structure its management more analogous to a partnership. Unless stated to the contrary in the regulations, the LLC would be managed by a group of managers who are annually elected by the members. The duties and responsibilities of managers are similar to those of directors of the corporation. Managers are permitted but not required to appoint officers to carry on the day-to-day business of the LLC. Although both may be members, neither managers nor officers of an LLC are required by the Act to be members.
The Texas Limited Liability Company Act provides members of the LLC like shareholders of a corporation are not personally liable for the debts of the LLC even if the members actively participate in the business. Like corporations, Texas LLC's will be subject to the Texas Franchise Tax.
If you are required to report employment taxes or give tax statements to employees or annuitants, you need an employer identification number.
If you have not asked for a number, send for one on Form SS-4, Application for Employer Identification Number. You can get this form at any IRS or SSA office. Use your identification number on all items you send to IRS and SSA.
You should have only one number. If you have more than one and are not sure which to use, please check with the Internal Revenue Service Center where you file your return. Give the numbers you have, the name and address to which each was assigned, and the address of your main place of business. IRS will tell you which number to use.
If you took over another employer's business, do not use that employer's number. If you don't have your own number by the time a return is due, write "Applied For" and the date you applied in the space shown for the number.
Common Law Employees - Anyone who performs services that can be controlled by an employer (what will be done and how it will be done) is an employee. This is so even when the employer gives the employee freedom of action, if the employer has the legal right to control the method and result of the service.
Employers usually provide the tools and place to work and have the right to fire an employee. Generally, people in business for themselves are not employees. For example, doctors, lawyers, veterinarians, construction contractors and others who follow an independent trade in which they offer their services to the public are usually not employees.
If an employer-employee relationship exists, it does not matter what it is called. The employee may be called a partner, agent or independent contractor. It also does not matter how payments are measured or paid, what they are called, or whether the employee works full or part time.
There is no employee class difference. An employee can be a superintendent, manager or supervisor. Generally, an officer of a corporation is an employee, but a director is not. An officer who performs no services, or only minor ones, and who neither receives nor is entitled to receive pay of any kind is not considered an employee.
Whether an employer-employee relationship exists under the usual common law rule will be determined, when there is any doubt, by the facts in each case.
Statutory Employees - For FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) tax, an employee is a person described in (a) and (d) below.
For FICA (Federal Insurance Contributions Act) taxes, an employee means any of the following that performs services for pay under the conditions below.
For FICA taxes, people in (a) through (d) are employees if:
For FUTA and SUTA tax the term employee means the same as for FICA taxes except it does not include full time life insurance salespersons or home workers.
Publication 539, Withholding Taxes and Reporting Requirements, gives examples of the employer-employee relationship.
If you want a decision on whether a worker is an employee, file FORM SS-8, Information for Use in Determining Whether a Worker is an Employee for Purposes of Federal Employment Taxes and Income Tax Withholding. The form is available at any IRS office.
Record the name and number of each employee as it appears on the employee's social security card. Any employee without a social security card can get one form any SSA office by completing FORM SS-5, Application for a Social Security Number. Forms are available at any SSA office and most post offices.
Wages subject to Federal employment taxes include all pay, whether in cash or other forms, you give an employee for services performed. This includes salaries, vacation allowances, bonuses, and commissions. It does not matter whether the pay is based on the hour, day, week, month or year, or on a piecework or percentage plan.
BASIC WAGE STANDARDS
FSLA
(Fair Labor Standards Act)
Covered non-exempt workers are entitled to a minimum wage and overtime at not less than one and on half times the employee's regular rate is due after 40 hours of work in the workweek.
This memorandum outlines the major city, county, and state requirements for starting a business in Houston as well as certain general taxation information. This information is not intended to be detailed and exhaustive. Before starting a business it is recommended that you made a detailed study of the business. Our office can also help you for advice and consultation. Our office number is 713-726-9972.
A listing of Texas State Taxes, licenses and fees is available from the Comptroller of Public Accounts at the State Capital in Austin. However, for convenience, you may contact one of the Houston offices of the State Comptroller. Contact with the Office of the State Comptroller is a must for all new businesses. Some of the more important taxes are summarized below:
The Franchise Tax on corporations is levied by the State of Texas on state-chartered and foreign corporations equally and is based on the invested capital, surplus, and long term debt of each corporation to the extent that the corporation does business in Texas.
The State of Texas levies severance taxes on oil, natural gas and sulphur. The rate of taxes is applied to the amount of production of these natural resources.
A number of different types of businesses operating in the State of Texas are subject to state taxes based upon business gross receipts. Several examples of types of businesses required to pay these taxes are telephone and telegraph companies, oil and gas well servicing firms, express companies and gas, electric and water utilities. Insurance companies are required to pay taxes on gross premium receipts.
The limited sales and use tax is imposed on the receipts from all retail sales of tangible personal property made in the State as well as upon storage, use of consumption in Texas of tangible personal property purchased, leased or rented from a retailer. The sales and use tax rate is 8.25% of the sales price, collected by the retailer from the consumer. Over 200 Texas cities have imposed an additional 1%, which is collected by the retailer and included with his payments to the State Sales Tax. The retailer engaged in business in Texas from the purchaser collects the use tax. Taxpayers are granted a 1% discount for collecting the tax plus 2% additional for payment. The Texas State Comptroller furnishes list of local offices, or the SBA will have them also.
The state of Texas levies a number of miscellaneous business license and inspection fees as well as "occupation" taxes. The amount of these charges will depend upon the nature of the business or occupation. Some examples of those subject to a tax of this nature are: brokers, emigrant labor agencies, public grain warehouses, citrus dealers, food and drug manufacturers, hospitals and firework dealers.
The Texas Employment Work Force has information on this tax. In Texas, employers of one or more individual during at least a portion of the day in each of twenty different weeks in a calendar year, and any other employers who may choose coverage, must pay a State unemployment tax.
CITY OF HOUSTON
LICENSES
In some cases there is an annual fee. Always contact the appropriate department for complete information. Making the initial contact by telephone will usually save time. Some businesses for which a license is required are:
To be safe, a call is recommended to the license division whatever kind of business you are starting.
The Building Code of the City of Houston Section 305, specifies that no building or structure in Groups A to H inclusive (this includes all but private residences), shall be used or occupied, and no change in the existing occupancy classification of a building or structure or portion thereof shall be made until the Building Official has issued a Certificate of Occupancy. Complete information on the Certificate of Occupancy can be obtained from the Building Inspection section, Public Works Department, City of Houston.
If a business is to be operated under an assumed name, the name under which it proposes to operate should be filed with Harris County. Prior to filing the assumed name, the records should be checked in the Office of the County Clerk to see if any other business is presently operating under that name.
Complete information on the Assumed Name Record and Certificate of Ownership is available from the Office of the County Clerk, Harris County Courthouse. A nominal fee is charged for filing.
The only County occupation license is a Pistol Dealer Permit. That license and all information pertaining to it and the fee can be obtained from the Office of Tax Assessor-Collector, Harris County Courthouse, 301 San Jacinto, Houston, TX 77002.
These licenses, fees and all information pertaining to them can be obtained from the Liquor Control Board, State of Texas.
You may obtain "Mr. Businessman's Kit" from the Internal Revenue service located on Room 1012, federal Office Building, 515 Rusk, Houston, TX. Be sure to obtain this kit as early as possible - before you need it.
This kit will give you the essential information on taxes applying to you, when and where to file returns and pay tax, samples of forms, and basic instructions. An IRS representative will explain this kit to you and answer any questions you might have pertaining to your tax responsibilities. IRS frequently conducts an orientation session (on Thursday afternoons, usually) for prospective business owners, which you would don well to attend.
You might also like to obtain "Tax Guide for Small Business" from the IRS. A new up-to-date "guide" is published annually.
Our office can also advise you on any tax matter concerning your business. You can reach us at 713-726-9972.
These are details for some of the business insurance you may need for your business:
We can advise you on any choice and the suitability of these policies. Our number is 713-726-9972.