Key Takeaways

  • In California, both LLCs and partnerships are pass-through entities for federal taxes, but LLCs can elect corporate taxation while partnerships cannot.
  • LLCs provide strong personal liability protection for members, while general partners in a partnership are personally liable for business debts.
  • Partnerships are generally easier and less expensive to form than LLCs, with fewer ongoing compliance obligations.
  • LLCs require filing Articles of Organization and paying an $800 annual tax in California, while partnerships often require only a partnership agreement.
  • Choosing between an LLC and a partnership involves comparing liability, taxation, management flexibility, formation costs, and long-term business goals.

The main difference you should understand between an LLC and a partnership is their liability protection. There are two types of partnerships which differ in terms of liability, formation, and in some cases, taxation. Unlike LLC's, partnerships do not offer owners protection from liability. Although both options are "pass-through" structures for filing taxes, an LLC can seek corporate election — partnerships cannot. An LLC follows a corporate business structure combining characteristics of a partnership and requires more paperwork when forming.

Choosing Business Entities in California

When deciding on the best entity for your business there are many factors to consider, including:

  • Liability protection
  • Taxation laws at the state and federal level
  • Management strategies
  • Structure of ownership
  • Funding consideration
  • Possible exit strategies

Each type of entity is unique in terms of the factors listed above. This is why it is important to review your options prior to formation. In California, you may form any of the following entities. 

  • Sole proprietorships and general partnerships
  • Limited partnerships
  • Limited liability partnerships (LLPs)
  • Limited liability companies (LLCs)
  • C-corporations
  • S-corporations

Factors to Consider When Comparing LLC vs Partnership

When deciding between an LLC and a partnership in California, you should evaluate several critical factors beyond basic formation requirements:

  • Liability Exposure: LLCs shield members from personal liability for business debts and claims, while general partners in a partnership remain personally responsible. Limited partnerships can limit liability for some partners but not for general partners.
  • Formation Costs: Partnerships generally cost less to form and maintain, while LLCs require state filing fees, an annual $800 franchise tax, and potential additional gross receipts fees in California.
  • Management Structure: Partnerships often operate with more flexibility and fewer formalities. LLCs allow members to choose between member-managed and manager-managed structures, which can offer more defined roles.
  • Tax Flexibility: Both structures are pass-through by default, but LLCs can elect to be taxed as an S corporation or C corporation, potentially reducing self-employment taxes.
  • Investor Perception: LLCs may be viewed as more formal and credible by lenders and investors compared to general partnerships.

An Overview of California Partnerships

If you're interested in forming a partnership, you will require two or more individuals who are entitled to a certain share of all profits. They will also have some level of authority when managing business-related affairs. This is true unless the business was purposely formed as an LLC, which we will discuss below. 

Within a partnership, a written agreement is not required. However, even if the business is small, has only two members, or is run by family members, a simple agreement should be created in order to address the basic fundamentals.

  • How will the profits be split?
  • How are the responsibilities shared among partners?
  • What will happen if one partner decides to leave?
  • What if the partnership wishes to take on a new member?

Each business is organized on a case-to-case basis, so make sure you understand how your partnership will operate and what that means for each partner. 

Types of Partnerships in California

California recognizes several types of partnerships, each with distinct liability and management features:

  1. General Partnership (GP): All partners share equally in profits, losses, and management responsibilities, but each partner is personally liable for business debts.
  2. Limited Partnership (LP): At least one general partner manages the business and is personally liable, while limited partners contribute capital and share profits but do not manage daily operations.
  3. Limited Liability Partnership (LLP): Common among licensed professionals (e.g., lawyers, accountants, architects), LLPs protect partners from certain liabilities while allowing them to participate in management.

Even if a written agreement is not required, creating one is highly recommended to define profit distribution, dispute resolution, decision-making authority, and procedures for adding or removing partners.

An Overview of California LLCs

Under the California Corporations Code, business owners can enjoy the benefits of a partnership while avoiding general liability by forming an LLC. The company itself will be held responsible for all debts and obligations. This means that the owners or "members" do not hold personal responsibility. The main downside to this structure is that members are subject to an annual tax of $800.

On a positive note, LLCs are flexible in that they avoid most of the burdens that corporations face. This includes special regulations in regards to shares, taxation, and distribution. LLCs also benefit in that they do not need to pay taxes at two separate levels, whereas corporations do. This is why in the state of California it often makes the most sense to form an LLC. 

California LLC Requirements and Compliance

Forming an LLC in California involves specific state requirements:

  • Articles of Organization: Must be filed with the California Secretary of State, including the LLC’s name, address, agent for service of process, and management structure.
  • Annual Franchise Tax: A minimum $800 tax applies, plus an additional fee for LLCs with California-sourced gross receipts above certain thresholds.
  • Operating Agreement: While not filed with the state, it governs internal operations and is essential for clarifying member roles, capital contributions, and dispute resolution.
  • Statement of Information: Due within 90 days of formation and every two years thereafter, disclosing key business and management details.

Failure to meet these requirements can result in penalties, suspension, or loss of good standing.

General Partnership vs LLC

Choosing the right business structure for your business is one of the most important decisions you will make within the initial stages of operation. When comparing a general partnership and an LLC, the main differences will be based on taxation and personal liability. 

When deciding on a partnership, you have two options:

  • General partnership — This will involve two or more individuals who agree to run a for-profit business together. In this case, you and your partner(s) would share equal responsibilities in terms of management. You would also split all profits/losses.
  • Limited partnership — This will involve at least one general partner who runs and finances the company, as well as another partner who only invests capital to the entity itself. 

If you would like to form an LLC, you can do so with one member or multiple members. This business structure includes features of both a partnership and corporation. When deciding which option is best for you and your company, consider four main variables: management, formation, profit-sharing, and legal liability. 

If you do decide to form an LLC, know that this will require more paperwork than a partnership. If there are multiple members, you should also create an operating agreement. As an LLC, you must file articles of organization. This documentation will include the name of your LLC (after you have conducted a thorough search), the location of the LLC, the owners' names/addresses, along with any additional statutory requirements. 

Comparative Advantages and Disadvantages

LLC Advantages:

  • Strong liability protection for members.
  • Flexible management and profit distribution arrangements.
  • Ability to elect S corp taxation to potentially reduce self-employment taxes.
  • Enhanced credibility with lenders and investors.

LLC Disadvantages:

  • Higher formation and maintenance costs in California.
  • Annual $800 franchise tax plus possible gross receipts fees.
  • More administrative requirements (e.g., statements of information, operating agreement).

Partnership Advantages:

  • Simple and low-cost formation.
  • Minimal ongoing compliance requirements.
  • Flexible internal management without required formalities.

Partnership Disadvantages:

  • General partners have unlimited personal liability.
  • Limited ability to raise capital from investors compared to LLCs.
  • No option to elect corporate taxation.

Frequently Asked Questions

1. Is an LLC always better than a partnership in California?

Not necessarily. LLCs offer liability protection and tax flexibility, but partnerships may be better for low-cost, simple operations without high liability risk.

2. Can a partnership later convert to an LLC in California?

Yes. Partnerships can convert to LLCs by filing conversion documents with the Secretary of State, though taxes and fees may apply.

3. Do LLCs and partnerships pay the same taxes in California?

No. While both are pass-through entities by default, LLCs must pay the $800 annual franchise tax and may owe additional fees based on gross receipts.

4. Who should choose a Limited Liability Partnership (LLP) instead of an LLC?

Licensed professionals in fields like law, accounting, and architecture often choose LLPs for liability protection while remaining in a partnership structure.

5. Is an operating agreement necessary for a California LLC?

Yes. Although not filed with the state, an operating agreement is essential for outlining management, profit distribution, and dispute resolution.

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