For decades, limited liability companyies (or LLCs) have been the entity of choice for numerous businesses and their owners. In particular, where single owners are involved, the formation and use of single member LLCs is ubiquitous. This is because single member LLCs still offer some creditor protection but are treated as disregarded entities (essentially ignored) for income tax purposes. However, notwithstanding their numerous benefits, California has unique tax rules that can sometimes make LLCs problematic. In particular, California imposes a one-of-a-kind fee or tax just on LLCs and this fee is based on the LLCs “gross” receipts. The higher the gross receipts…the higher the fee (it can be nearly $12,000 a year). Because the fee is based on gross receipts, an LLC can have little to no profits but yet still be subject to the full fee. Thus, any entity that has high sales volumes and low profits should not be structured as LLCs. Unfortunately, this gross receipts tax even applies to single member LLCs that are disregarded for federal income tax purposes. As a result, if gross receipts tax wil be an issue people tend to utilize S Corporations. However, while S corporations have some tax advantages of their own, they have stringent rules on stock ownership and it is not ideal for S Corporations to own real property because getting appreciated property out of the S Corporation is nearly impossible.
Enter the “single member limited partnership”. With some careful planning, a limited partnership can be structured so that it is considered to be owned by a single person/entity and will be disregarded for income tax purposes. As an added benefit, the limited partnership is not subject to any form of gross receipts tax. Often, people shy away from the use of limited partnerships because it requires two partners, one of which must be a general partner who will ultimately be liable for all the partnership’s debts. However, an LLC can be used and named as the general partner in order to provide liability protection. The key to making the limited partnership as a disregarded entity is to ensure that the LLC that is formed to hold the general partner interests is itself a disregarded entity. The IRS has clearly announced that when you have a state limited partnership with two partners, and one of the partners is a disregarded entity of the other partner, then for income tax purposes the limited partnership will be ignored and treated as a disregarded entity. (See Rev. Rul. 2004-77) Typically, the LLC will just be given a small (say 1%) interest in the limited partnership so that the LLC itself should not be subject to the gross receipts tax.
However, keep in mind that the Board of Equilization does, in certain circumstances, have the statutory authority, in its apparent discretion, to aggregate and assign income earned by a parntership to a LLC (for purposes of the gross receipts tax) if the partnership and LLC are owned by a common owner. (See Cal. Rev. & Tax Code 17942(b)(2).) I am not aware of the BOE utilizing this provision but it is important to be aware of this rule’s existence and potential application.