LLC Formation in Texas

Introduction

This article is tailored for those wishing to form an LLC for purpose of holding real estate investments. The first thing investors should know about limited liability companies is this: get one. There are lots of good reasons. The main ones are (1) minimizing personal liability and maximizing asset protection; (2) organizing your investment business; and (3) tax benefits including one-time taxation of members' profits.

Company Identity

A limited liability company, like a corporation, is a distinct legal entity with a life of its own. It has its own rights and duties. It files its own tax returns. However, it requires maintenance and continued respect for its independent status. It may be your company, but it must still be treated at arms length for legal purposes. You must undertake certain actions to maintain its separate character, and it is vital that you do so if you wish to avoid personal liability for the actions of the company or its agents and employees. The reason is the legal doctrine of "piercing the corporate veil." Unless the company pays its state and federal taxes, maintains a bank account, conducts regular meetings, keeps records, and the like, then in the event of a lawsuit, a court may disregard the company's existence and proceed directly against the members/owners personally. It will be alleged by the plaintiff's attorney that the company is a sham and nothing but the personal "alter ego" of its owners, designed to shield them from the consequences of wrongful conduct.

Omitting company "maintenance" is the single biggest mistake that investors make concerning their companies. They do the initial paperwork, pay a filing fee, and then use the company name in transactions without ever doing another thing to maintain the form and substance of the company's existence. This approach provides only the illusion of personal liability protection. It will not protect you from a clever plaintiff's lawyer who is determined to get a judgment against you personally. Remember, he or she will be looking for deep pockets and hard assets, wherever they can be found.

A new lawsuit is filed every 1.3 seconds. Literally millions of lawsuits will be filed this year. Many will award huge damages for such things as serving coffee that is too hot. In this legal environment, proper asset protection is a serious matter.

Where to Form the Company

Consult your attorney to determine whether an LLC best meets your needs. For reasons of simplicity and economy it is recommended that new investors start with a Texas LLC. There should be no rush to get chartered in another state since Texas has favorable LLC laws. Nevada and Delaware are also good choices, although out-of-state LLC's are required to pay a stiff fee and maintain a registered agent with a physical address (ie., not a PO box) in order to do business in Texas.

After establishing your LLC, you may wish to file a "DBA" certificate in the counties in which you operate, showing the name under which you will be publicly doing business. This further preserves anonymity, an important element in asset protection.

Members

The owners of an LLC are referred to as "members" rather than shareholders or partners. An LLC may be formed by only one person. Members may be individuals, partnerships, other LLC's, corporations, and/or any other type of legal entity. LLC's generally operate through a "managing member" although officers may also be elected if the company agreement (formerly called the bylaws) so provides.

Ideally, the personal name of a member should never appear on any deeds or leases, and a tenant should never write a check to a member personally. Do business using the name of the LLC (or its assumed name - DBA - if you have obtained one) and use a dedicated operating account. Avoid any form of personal guaranty on legal documents. Property management should always be conducted by your LLC.

Asset Protection

A primary purpose of an LLC is to provide asset protection for its members. Although there is no such thing as a "bulletproof" plan to avoid personal liability or protect assets, the rule is this: the more fences a plaintiff and his attorney have to jump, and the more money they have to spend in order to get to you personally, the better protected you are. One way or another, plaintiffs have to pay their lawyers, and that means either cash or contingent fee - and few good lawyers will take a real estate fraud case on a contingent fee, particularly if they know they will have to penetrate a bona fide LLC before they can get to any real assets.

It is critical that your attorney draft the LLC's company agreement so that it discourages creditors from ever attempting to seize your membership interest or the membership interest of a fellow member. A membership interest in an LLC is not a protected asset under the Texas homestead laws - so provisions should be included in the company agreement to the effect that any creditor succeeding to a membership interest by means of collection or execution on a judgment will not be able to vote that interest; not be able to serve as a manager or officer; not be able to direct that assets of the company be sold; and not be able to alter or reduce the company's ability to do business. A related article on our website, Asset Protection in Texas may be useful to you.

Separating LLC From Personal Affairs

An LLC is also a useful device for organizing your business, particularly in separating your business from personal affairs. Failing to do this is a common mistake of novice investors and can create legal and accounting problems. Running business income and expenses through your personal account may not be illegal, but it can complicate your defense if you are sued. It will be alleged that you "commingled funds." Again, this may not always be contrary to law, but it will arouse the suspicion of the judge and jury and may result in your defense failing the "smell test." This sort of error can also result in your being held personally liable for damages. Why risk it?

The Company Name and Other Formation Details

In setting up an LLC, one of the first things to consider is a company name. Unfortunately, the easy ones tend to be taken, so you will need to be creative. When you have an available name, contact your attorney and tell him who the original members are going to be and what percentage of ownership each will have. Generally, LLC's have a managing member or co-managing members. Who will be serving in these capacities? You will also need to choose a registered agent with a physical address (not a PO Box) in Texas. The registered agent will receive official company mail from the Secretary of State and the Comptroller and be the person who is served with process if the company is sued.

State and Federal Taxes

An LLC differs from a conventional corporation in that it avoids "double taxation," ie., taxation on corporate profits and then taxation again when dividends are paid to the owners. Income passes through to the individual members of the LLC with only one taxable event. In this way, an LLC is treated similar to a partnership for federal income tax purposes. Your LLC will need to obtain a TIN (taxpayer identification number) using an SS-4 form (supplied with our company kit) or the TIN can be applied for online. The TIN will be required to open a bank account for the LLC.

Although Texas does not have a personal income tax, it does have a franchise tax (also called the margin tax) that is imposed on all "taxable entities." The statutory definition of a "taxable entity" can be found at Texas Tax Code Sec. 171.0002(b)(2), but it includes LLC's. The margin tax is basically a modified gross receipts tax, although some thresholds and deductions apply. A franchise tax return must be filed annually with Texas Comptroller.

Note that obtaining a TIN and filing tax returns are part of what an LLC must do in order to preserve its status as an independent entity with a liability barrier that protects its individual members.

Moving Property into the LLC

If possible, any investment property you may acquire should be acquired in the name of the LLC. Any and all investment property acquired or currently held in your personal name should be moved into the LLC by means of a general or special warranty deed without delay. Investors occasionally wonder if this is permitted by the lender if there is a "due on sale" clause in their deed of trust. This is usually not a problem. Go to our companion article Due on Sale Clauses in Texas for more information.

Use of Internet Services to Form Your LLC

NO serious businessman or investor would do this. Here is what such services do not provide:

NO comprehensive advice on how to structure your business and investments so as to achieve maximum asset protection

NO attorney to serve as organizer, initial member, and/or registered agent in order to maximize your anonymity

NO sophisticated company agreement that deters creditors from taking control of your company

NO advice on how to move property into the LLC after it is formed

NO advice on how to set up and arrange the LLC's finances, including setting up LLC accounts, injecting capital, and/or loaning money to the LLC

NO advice on how to maintain the LLC liability barrier to prevent a plaintiff from "piercing the corporate veil"

NO free follow-up questions after the LLC is formed

Additionally, the documents provided by such services are minimal in nature and not adequate for purposes of asset protection.

Summary

Every investor should consider having at least one LLC (although it is not a good idea to form more entities than are useful or necessary in carrying out an investor's business). For a summary of the core documents pertaining to LLC's - the Certificate of Formation, the Minutes of the First Meeting of Members, the Company Agreement, and annual and special meetings - see our companion article at our website, LLC Documents in Texas.

DISCLAIMER

Information in this article is proved for general educational purposes only and is not offered as legal advice upon which anyone may rely. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.

Copyright © 2009 by David J. Willis. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his web site, http://www.LoneStarLandLaw.com.

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