When you form a business you can choose to form the business using different legal structures. If you are considering starting a business with at least one other person, you may want to consider forming a partnership. In California you can choose from four different partnership types, each offering different advantages.
Types of Partnerships: Liability & Tax Considerations
The type of legal structure you choose for your partnership will determine how the business, and you as an owner, are taxed. Partnerships are commonly considered pass-through entities, meaning the profit they generate is passed through to their owners’ personal incomes. The IRS has additional requirements regarding filing federal taxes with partnerships.
Personal liability is the other important topic to consider when forming a business. Liability refers to how many of your personal assets are able to be seized when the business has to settle a debt. The reverse is true as well, meaning your business assets may be used to settle your personal debts.
The types of partnerships offered in California are compared below, with information highlighting the differences in liability and tax considerations.
General Partnership (GP)
Liability of partners: In a general partnership, partners are jointly and severally liable for the business debts. This means that if anything happens to the business, all of the partners are equally responsible. There is no liability protection offered by a GP. This means there is no legal separation between personal and business assets, and either can be seized to settle debts.
Tax overview: In California, GPs are considered pass-through entities. This means that the partners must divide the income generated or the losses incurred by the business and report it on their individual state and federal tax returns.
Limited Partnership (LP)
Liability of partners: Similar to a general partnership, a limited partnership has two types of members: general and limited. The limited partners to do not manage the day to day operations of the company but are only liable for their personal investment in the business. General partners have the authority to run the business but are fully liable for the company’s debts. This type of partnership is common when investors are needed to get the business up and running because limited partners are able to invest in the business without being held responsible for all of the company’s debts.
Tax overview: Like GPs, LPs are considered pass-through entities and the partners must report their share of the income or losses of the company on their individual tax returns.
Limited Liability Partnership (LLP)
Liability of partners: In California, LLPs are only available to individuals who are attorneys, architects or accountants. Under the LLP structure, each partner is only legally responsible for his or her own actions and liabilities. Since these professions face a high risk of liability, this protects the members from each other’s debts and legal liabilities.
Tax overview: Like GPs and LPs, LLPs are considered pass-through entities for tax purposes and each partner is responsible for reporting his or her income generated by the business on his or her individual tax returns.
Limited Liability Company
If you need additional taxation choices or greater protection from personal liability you may want to consider forming a limited liability company (LLC). The LLC business structure combines many of the advantages of partnerships while offering greater flexibility in tax structures. On the downside, they often require more effort to maintain than a partnership but even then, they are known for their simplicity.
How to Form a Partnership in California
After deciding on which partnership form you would like to use for your new business, you will need to take a few steps to legally operate your business in California.
Step 1: Select a business name
If your business will be operated as anything other than a general partnership, you must include the appropriate designation (LP, LLP, LLC) within the company name to provide your clients with notice of the legal limits on liability provided by these business forms.
So, if you are forming a new law firm as an LLC and want to name the firm The Tenants Advocacy Firm, you must include the LLC at the end of the firm name. Thus you would be The Tenants Advocacy Firm LLC.
Step 2: Register the business name
To operate a business as any type of partnership in California, you must file a Fictitious Business Name Statement. This must be done at the Office of the County Recorder in the county of the partnership’s principal place of business, also called the company’s headquarters or primary business location.
Step 3: Complete required paperwork
General Partnerships (GP) – In California, businesses may file a Statement of Partnership Authority with the Secretary of State to formalize their business partnership but general partners are not required to do so in order to operate a business in the state.
Limited Partnerships (LP) –In California, in order to form a LP, you must file a Certificate of Limited Partnership with the Secretary of State.
Limited Liability Partnerships (LLP) – In California, in order to form an LLP you must file an Application to Register a Limited Liability Partnership (LLP). The LLP is also required to maintain liability insurance or file an LLP-3 Alternative Security Provision of a Limited Liability Partnership (LLP).
Limited Liability Companies (LLC) – In California, in order to form an LLC you must file the Articles of Organization of a Limited Liability Company (LLC) with the Secretary of State.
Step 4: Determine if you need an EIN, additional licenses or tax IDs
Partnerships with employees should obtain an Employer Identification Number (EIN) from the IRS. Additionally, some businesses require additional licenses from the state in order to operate. Further taxes may be required as well, depending on your business.
Step 5: Get your day to day business affairs in order
After registering your business name and filing the appropriate forms with the Secretary of State, you can now operate your business in California. If you haven’t already done so, you should make sure you have your basic business services set up, including:
- Open a bank account for the business
- Create a website for the partnership
- Open social media accounts for the business
- Get insurance for the business
Ready to start a partnership? LegalZoom will help you choose which type of business partnership may be right for you. We can also file the paperwork to form your business, help you find a registered agent, and get you in touch with an attorney or tax professional.