Experienced Business Attorneys

Partnerships involve two or more individuals or entities actively managing a jointly owned business. It allows for resource pooling and cost-sharing but also entails shared personal liability for business debts. Partnerships can be formed without formalities or registration. However, be cautious. In these typical partnerships, individuals become general partners and bear the burden of unlimited personal liability. Engaging in “general” partnerships can pose significant risks for operational businesses, as both partners may be vulnerable to legal actions and financial losses. To mitigate personal liability and protect their assets, partners should consider exploring alternative partnership structures or entirely different business entities.

For tax purposes, partnerships are subject to taxation in a manner similar to sole proprietorships, with income being distributed among individual partners. Partnerships are categorized as pass-through or flow-through entities, signifying that income and losses pass directly through the partnership without encountering taxation at the partnership level. Each partner is responsible for reporting their respective portions of income, losses, deductions, and credits on their individual tax returns. Consequently, every dollar earned by the partnership is subjected to taxation only once, at the partner’s level. This distinction is crucial and sets partnerships apart from certain corporations, which face the potential for double taxation, a concept explored in the following paragraphs.

Corporations come in two categories: C-corporations and S-corporations. C-corporations are usually larger and subject to double taxation, while S-corporations are limited to 100 shareholders and offer pass-through taxation. Because they can be lager, C-corporations are types of business structures optimal for an organization planning to expand, attract investors, or even go public.

The key difference between C- versus S-corporations are how they taxed. On the one hand, C-corporations pay state and federal taxes on the income the corporation earns. In essence, the same money twice gets taxed twice, called double taxation. On the other hand, S-corporations are more tax-efficient but have specific eligibility criteria. If set up correctly, a qualifying S-corporation can avoid the double taxation.

LLCs combine the advantages of corporations and partnerships, offering flexibility in ownership, management, and taxation. LLCs can serve various purposes, including a practical method for owning investment real estate. Within an LLC, members assume ownership and management roles while maintaining limited liability. Moreover, they have the flexibility to choose their preferred tax treatment, resembling either a partnership, a corporation, or a disregarded entity, where the IRS disregards the LLC for tax purposes. State income tax returns are necessary for LLCs, but they avoid federal income tax returns. Instead, members report their share of income or losses on their individual tax returns, eliminating double taxation concerns.

Compared to corporations, LLCs generally have less stringent regulatory requirements, reducing the likelihood of veil-piercing. Thus, an LLC can be an effective choice to mitigate double taxation while preserving limited liability. It may also play a role in estate planning for business owners looking to pass on assets to future generations with minimized tax liabilities. However, it’s crucial to consider your specific circumstances, as certain professionals, like lawyers, doctors, and real estate agents, may face restrictions when operating as LLCs in California. The suitability of an LLC depends on your unique business context.