Practice Areas › Business and Corporate Law
LLC, Corporation or Partnership
Almost everyone asking this is asking a tax question in legal clothing. The liability answer is usually the same across the options; the tax answer is not, and neither is what happens when the owners fall out.
The real question
Three things actually differ.
How the profits are taxed. Whether income is taxed once at the owner level or twice, whether losses flow through, and whether earnings are exposed to self-employment tax. For most closely held businesses this is the decision.
How flexible the economics can be. A corporation divides everything by share count. An LLC or partnership can allocate profits, losses and distributions in ways that do not track ownership percentages at all — which is why funds and joint ventures use them.
What outside money expects. Institutional venture investors generally want Delaware C corporations, because their own structures and the option pool assume it. Choosing otherwise is not fatal, but it means a conversion later, at cost.
Liability protection is not the differentiator. LLCs, corporations and limited partnerships all get it, and all lose it the same way — by ignoring formalities, mixing funds, or personally guaranteeing the debt.
For all six forms compared feature by feature, with the California and Delaware rules that change the answer, see the Business Entity Comparison Chart.
LLC — Limited Liability Company
The default for closely held businesses, real estate and joint ventures.
Taxation
Pass-through by default. Can elect to be taxed as an S or C corporation without changing the legal entity.
Economic flexibility
The strongest of the four. Allocations, distributions, preferred returns and profits interests can be built almost freely in the operating agreement.
Governance
Member-managed or manager-managed. Few statutory formalities — which is a benefit and a trap.
Watch for
Self-employment tax on active members. California fees below. In California an LLC cannot practice a licensed profession, though some licensed trades, such as contractors, can use one.
S Corporation
A tax election, not an entity type. An LLC or corporation can make it.
Taxation
Pass-through. Its usual attraction is splitting income between salary and distributions, reducing self-employment tax on the distribution portion.
Economic flexibility
Rigid. One class of stock. Every distribution and allocation must be strictly proportionate to ownership.
Governance
Corporate formalities apply — meetings, minutes, resolutions.
Watch for
Hard eligibility limits: 100 shareholders maximum. US citizens and residents, estates, certain trusts, and charities and retirement plans. No partnership or corporation can own shares. Salary must be reasonable and is examined.
C Corporation
What institutional investors expect, and what public markets require.
Taxation
Taxed at the entity level, and again on dividends. Double taxation matters far less if earnings are reinvested rather than distributed.
Economic flexibility
Multiple share classes, preferred stock, option pools, convertible instruments. Built for outside capital.
Governance
Board, officers, bylaws, full formalities. Familiar to every investor and every acquirer.
Watch for
Losses stay trapped at the entity and do not flow to owners. Distributing profits is expensive.
Partnership — General and Limited
The structure funds and syndications are built on.
Taxation
Pass-through, with the same allocation flexibility as an LLC.
Economic flexibility
Very high. Waterfalls, preferred returns and carried interest are partnership constructs.
Governance
A general partner manages; limited partners do not. A limited partner who helps run the business risks personal liability, but only toward someone misled into thinking that partner was a general partner.
Watch for
General partners have unlimited personal liability — which is why the general partner is itself almost always an LLC or corporation.
California
Two state rules that change the answer.
Most licensed professionals cannot use an LLC in California
California prohibits an LLC from rendering professional services, and — unlike most states — it offers no professional LLC as an alternative. Lawyers, doctors, accountants, architects and others use a professional corporation instead. Some licensed trades can use an LLC where their own licensing law allows it, and contractors are the common example. This is a common and expensive surprise for someone incorporating from out of state.
The LLC fee is two charges, not one
Every California LLC pays the $800 annual franchise tax regardless of income or activity. On top of that sits a separate fee driven by California-source gross receipts — gross, not profit, so a high-turnover, low-margin business can owe a substantial fee in a year it lost money.
California-source gross receipts
Fee
Under $250,000
$0
$250,000 – $499,999
$900
$500,000 – $999,999
$2,500
$1,000,000 – $4,999,999
$6,000
$5,000,000 and above
$11,790
Amounts set by statute (Rev. & Tax. Code §17942), and in addition to the $800 annual tax. Confirm current amounts before relying on them.
Traps
What goes wrong, and when.
The entity is chosen and the agreement is not written
Filing with the Secretary of State takes a day. It settles almost nothing. The operating or partnership agreement is where distributions, deadlock, transfer restrictions, removal and buyout actually live — and a default statutory rule will govern anything the document does not address, usually not the way the owners assumed.
Two owners, fifty-fifty, no tiebreaker
An even split with no deadlock mechanism is the most common structural defect in a closely held business. It works perfectly until the first serious disagreement, at which point neither owner can act and neither can leave without the other’s consent.
Choosing for today’s tax bill instead of the exit
The tax-efficient structure while earning is often the wrong one when selling. Buyers frequently want assets rather than equity, and the entity form determines who bears that cost. Converting later is possible and can itself be taxable.
Forming in Delaware for no reason
Delaware makes sense when institutional investors expect it or the governance case is real. For a business operating in California with California owners, it usually means registering as a foreign entity in California anyway — paying both states, filing in both, and gaining nothing.
Formalities abandoned after year one
Liability protection is not conferred by the filing; it is maintained by conduct. Separate accounts, real records, documented decisions and no personal use of company funds. The shield fails on the facts, not on the certificate.
This page is general information, not legal or tax advice. How it applies depends on facts this page cannot know, and the rules change. Reading it creates no attorney-client relationship. Please see our Attorney Advertising, Legal Notices & Disclaimers.
Forming something, or restructuring one?
The entity is the easy part. The agreement between the owners is the part worth spending time on.
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