Before LLCs, S-corps, and Delaware holding companies, there was the general partnership (GP). It’s the oldest form of business organization, two or more people agreeing to work together, share profits, and (critically) share liabilities. No filing needed, no state charter, just a handshake and the beginnings of a business.
GPs trace their DNA all the way back to English common law. Under English common law (which heavily influenced U.S. legal systems), a partnership was created by conduct, not paperwork. If two or more people carried on a business for profit, they were presumed to be partners, whether they knew it or not. This made GPs the de facto structure for merchants, lawyers, artisans, and family businesses throughout the 18th and 19th centuries.
For much of the pre 1970s U.S. business history, general partnerships were the default. Law firms, accounting practices, family businesses, etc. If it wasn’t a corporation, it was likely a GP. The structure offered simplicity and tax efficiency, long before “pass-through” became a planning buzzword.
Courts developed doctrines to govern profit-sharing, fiduciary duties, and dissolution in the absence of formal contracts. That legacy persists today, meaning two or more persons (including individuals, trusts, or even other entities) who co-own and operate a business without forming a distinct legal entity may still be treated as a general partnership under the law, inadvertently exposing themselves to joint liability. It’s a trap we occasionally see with small family ventures, side hustles or informal real estate deals among friends. It’s instructive to look at two major jurisdictions and the differences between them, to help illustrate this point.
California vs. New York: How State Law Shapes the Risk of Inadvertent Partnerships
While general partnerships are governed by similar principles nationwide, the legal threshold for forming a partnership by conduct, not paperwork, can vary significantly between states. For advisors and clients in high-liability professions or high-value family ventures, the jurisdictions of California and New York help illustrate how nuanced these differences can be.
California: Intent and Context Matter
California has adopted the Revised Uniform Partnership Act (RUPA), which defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit” even without a formal agreement.
However, California courts often look beyond surface-level facts. They weigh whether the parties truly intended to act as partners, and whether their conduct reflects co-ownership rather than mere co-investment or collaboration.
Example: Two developers split profits from a project but maintain separate roles, books, and control, California courts might find this insufficient to create a GP, especially if the parties explicitly disclaimed a partnership in writing.
In California, documentation and context carry real weight. A well-drafted Joint Venture or Operating Agreement that expressly disclaims partnership treatment can help mitigate liability exposure, even if profits are shared.
New York: Profit Sharing Can Trigger Partnership Status
New York still follows the older Uniform Partnership Act (1914), which takes a more mechanical approach: if parties share net profits from a business, that’s presumptive evidence of a partnership, even absent a formal agreement or express intent.
Example: Two siblings split rental income from a jointly owned building and occasionally coordinate maintenance, New York law may view this as a de facto partnership unless carefully structured to avoid that conclusion.
In New York, the bar is lower than in California. The combination of co-ownership, shared profits, and even modest operational coordination can trigger GP treatment and joint liability. Clients need clear entity structures or written agreements to avoid unintentional exposure.
GPs and Why They Fell Out of Favor
The same feature that made GPs simple also made them dangerous: joint and several liability. Each partner is personally liable for the full debts and obligations of the business, even those incurred by another partner. Consider this: two partners operate a consulting business as a general partnership. One signs a lease for expensive office space without telling the other. The business folds six months later. The landlord sues both partners and wins a judgment. The second partner, who never saw the lease, is still on the hook personally. Their home equity, savings, and personal assets could be at risk if not protected by exemption statutes.
This unlimited liability, paired with the lack of a protective entity shield, led to an exodus once LLCs entered the scene in the 1990s. The LLC, first enacted in Wyoming in 1977, then adopted widely across the US in the '90s, combined pass-through taxation with corporate-style liability protection. These innovations rendered the traditional GP obsolete for most new ventures.
Where We Still See GPs
Despite their decline, general partnerships remain surprisingly common in the investment world:
- Private Equity and Hedge Funds often use a GP/LP structure, where the GP controls the fund and the LPs contribute capital.
- In these cases, the GP is usually a shell entity (often an LLC or LP itself), created to preserve control and allocate carry—not to expose principals to risk.
- Legacy Family Partnerships, particularly those holding real estate or mineral rights, may still operate as GPs simply because no one has bothered to change them.
Tax Profile & Allocation Complexity
General partnerships are taxed as pass-through entities meaning income, deductions, gains, and losses are reported directly by the partners. There’s no entity-level tax, and capital gains retain their character on distribution. This structure provides a powerful planning benefit: flexibility in profit and loss allocation. These ideas also transfer to other entities taxed as partnerships – LPs and LLCs.
But that flexibility comes with rules. Under Internal Revenue Code §704(b), partnership allocations must have substantial economic effect, a legal standard, designed to ensure that tax allocations reflect actual economic arrangements, not just tax arbitrage. For an allocation to pass muster, the partnership must:
- Maintain accurate capital accounts in accordance with tax rules,
- Ensure liquidating distributions match capital account balances, and
- Require partners to restore deficit balances or meet an alternative safe harbor.
While these principles were developed in the context of general partnerships, they apply equally to limited partnerships and LLCs taxed as partnerships. The tax code doesn't distinguish based on state-law entity types, it focusses on whether the entity is taxed as a partnership, and whether the allocation rules respect the deal’s economic substance.
Beyond allocation rules, partnership taxation demands:
- Meticulous basis tracking (both inside and outside basis),
- Awareness of Section 704(c) built-in gain rules when assets are contributed at different values,
- 754 elections when interests change hands through gift, sale, or death, and
- Coordination of capital account adjustments for trusts and multigenerational transfers.
For estate planners and wealth advisors, this complexity means one thing: if you’re using a partnership to facilitate gifting or legacy strategies, the tax mechanics must be built into the planning, not bolted on afterward. An elegant estate structure with poor capital account hygiene is a ticking time bomb.
Estate Planning Considerations
- Valuation Discounts: GP interests, especially non-controlling, non-marketable ones, can unusually be transferred at a discount. Useful for intrafamily gifting or seeding a trust.
- Transfer Risks: Because liability is tied to ownership, gifting GP interests to trusts or younger family members can create real legal exposure if not restructured properly.
- Transition Tool: More often, we see GPs used as stepping stones, entities to be recapitalized or converted into LLCs as part of a larger succession plan.
Advisor Insight
When you encounter a GP today, it’s either a high-end investment structure or a legacy arrangement. In either case, your role is to ask: Does this still serve its purpose? Can we better protect the family or the firm with a liability-shielded alternative? And if gifting or transferring interests, has someone actually read the partnership agreement lately? Because in GPs, the fine print, and the risk, belongs to everyone.
Limited Liability Company (LLC): The Estate Planner’s Workhorse
The Limited Liability Company (LLC) is now the default entity of choice for most closely-held businesses, and with good reason. Formed under state law by filing Articles of Organization (or a similar charter), an LLC combines corporate-style liability protection with the tax flexibility of a partnership.
Since Wyoming introduced the structure in 1977, LLC statutes have been adopted, and customized, by every U.S. state. By the mid-1990s, the IRS had codified LLCs as default pass-through entities under the “check-the-box” regulations, triggering their widespread adoption.
Today, LLCs are used to hold operating businesses, real estate, private equity, intellectual property, and family investment portfolios. They are a cornerstone of modern estate planning because they allow advisors to balance control, tax efficiency, and transfer flexibility across generations.
Why LLCs Took Over
LLCs solved the exact problem that doomed general partnerships: unlimited personal liability. A properly maintained LLC protects its members from business debts, litigation exposure, and contract obligations, shielding personal assets without the double taxation of a C-corp. They also offer:
- Customizable governance via operating agreements
- Flexible management structures (member-managed or manager-managed)
- No ownership restrictions (unlike S-corps)
- Fewer statutory formalities than corporations (no board meetings or resolutions required unless specified in the operating agreement—but maintaining internal documentation is still smart risk management)
Think of an LLC as a “legal wrapper” for assets or activities, it can be simple or sophisticated depending on the planning need.
From Paper to Practice: Forming an LLC in New York
While LLCs are often praised for their simplicity, forming one, especially a multi-member entity designed for wealth transfer, asset protection, or family governance, isn’t a “check-the-box” task. Each step has implications that ripple across tax, liability, and estate planning. Using New York State as a representative jurisdiction, here’s how a properly structured LLC comes to life and why each decision matters. Each jurisdiction has its own quirks, always check state-specific rules for clients in other locations.
1. Naming the Entity: Clarity and Containment
Every LLC starts with a name. In New York, that name must be distinguishable from other business entities on file and must include the words “Limited Liability Company” or “LLC.”
The name is more than a label, it signals legal separateness. If the LLC is holding legacy family assets or operating a business, that name becomes the firewall between personal and entity liability. A clear, distinct name also prevents confusion in IRS filings, bank accounts, and legal documents reducing audit risk and administrative tangle.
2. Filing Articles of Organization: Legal Birth
This is the formal act of creation: submitting Form DOS-1336-f to the NY Department of State. The Articles include the LLC’s name, county of formation, and designation of the Secretary of State or another party as agent for service of process. It can be submitted online or by mail, and the filing fee is $200.
Filing the Articles of Organization is what gives the LLC its legal identity, it’s the difference between an informal business venture and a recognized entity. But make no mistake: this step is easy by design. It’s not a heavy lift, and that’s what makes it dangerous. Without a properly crafted operating agreement and follow-through on the other foundational tasks (publication, EIN, banking), this document alone does not create a fully functioning estate or asset protection structure.
3. Drafting the Operating Agreement: The Heart of the Entity
New York requires that the members enter into an operating agreement within 90 days of formation, though it’s not filed with the state.
This document defines the rules of the road: who controls what, how profits are split, when distributions are made, how interests are valued and transferred. For estate planners, it’s where discounts, restrictions, control structures, and buy-sell mechanisms live. The absence of a signed agreement can result in state default rules and disputes between heirs, trustees, or advisors later on.
4. Satisfying New York’s Publication Requirement: A Local Quirk with Real Consequences
Within 120 days of formation, New York law requires new LLCs to publish a notice of formation in two local newspapers, one daily and one weekly, for six consecutive weeks, as designated by the County Clerk in the county of formation. After publication, the LLC must file a Certificate of Publication with the Department of State, accompanied by affidavits from the newspapers and a $50 filing fee.
While the requirement may feel archaic, failure to comply prevents the LLC from bringing legal actions in New York courts until it cures the defect. That means the entity can't enforce contracts, pursue litigation, or fully protect its interests leaving it legally hamstrung in the eyes of the state.
The publication rule dates to a time when local newspapers were the primary vehicle for legal notice. It reflects the legal fiction that the public needs to be “on notice” of a new business operating in their area, essentially an analog precursor to today’s digital registries and search databases.
Despite the rise of searchable online business databases, New York has preserved this requirement, particularly as a revenue stream for local publications and a formal step to reinforce that an LLC is not simply a private shell but a visible, active participant in the commercial ecosystem.
Clients forming LLCs in New York often assume this step is optional or symbolic. It’s not. While failure to publish doesn’t dissolve the LLC, it can paralyze it in the eyes of the court system and that’s a risk estate planners can’t afford when litigation, enforcement, or contract defense is even remotely possible.
5. Obtaining an EIN: Opening the Tax Identity
Every LLC needs an Employer Identification Number (EIN) from the IRS. This is required to open a bank account, hire employees, or file tax returns (even if the LLC elects to be disregarded for income tax purposes).
An EIN ensures the LLC is seen as a separate legal and tax entity. For multi-member LLCs, it’s the foundation for pass-through taxation. For single-member grantor trusts, the EIN allows for tax reporting to the grantor while maintaining entity separation. It also avoids mixing family and business accounts.
6. Opening a Business Bank Account: Asset Separation in Action
Once the EIN is secured, the LLC opens its own bank account, ideally one that matches the name used in the Articles of Organization and on IRS records.
This is where liability protection becomes real. Commingling funds between the LLC and its owners is one of the most common mistakes that pierces the veil. In estate planning, clean accounts also simplify accounting, reporting, and distributions to trust beneficiaries or family members.
7. Staying in Good Standing: Compliance Isn’t Optional
New York requires a Biennial Statement to be filed every two years, confirming the LLC’s address and registered agent. The fee is modest ($9), but the penalty for missing this, and losing good standing, can disrupt gifting, estate transfers, and even distributions.
Advisors often forget that an inactive or lapsed LLC can’t reliably function as a gifting vehicle, tax reporting entity, or asset protector. If an LLC falls out of compliance, its legal separateness can be challenged, putting personal wealth at risk.
Forming an LLC isn’t just a technical task, it’s a foundational act of structure. When done right, it sets the stage for controlled gifting, multigenerational governance, and valuation strategies that preserve wealth and reduce conflict. When done sloppily, it invites IRS scrutiny, family disputes, and unintended liability.
Maintaining the LLC: Keeping the Shield Intact
Forming an LLC is relatively easy. Preserving its legal and financial integrity over time is what separates a protective entity from a pierced one. Whether the LLC holds an operating business, a family investment portfolio, or legacy real estate, ongoing maintenance is essential to preserve the liability shield and ensure the structure supports estate planning and tax goals.
Here’s what proper upkeep looks like and what advisors should be watching for.
1. Treat It Like a Separate Entity
The golden rule of LLC maintenance is simple: treat the LLC like it’s not you. That means respecting the boundaries between personal and company activity at every level. What that means in practice:
- Open and maintain a separate LLC bank account
- Never pay personal expenses from the LLC (or vice versa)
- Title all LLC-owned assets in the entity’s name, not a member’s name
- Execute contracts, leases, and agreements as the LLC, not as individuals
Courts will look at these habits when deciding whether to honor the LLC’s liability shield. If the entity appears to be a personal piggy bank or informal extension of the owner, a creditor could “pierce the veil” and pursue personal assets.
2. Keep Good Books—and Know What That Means
LLCs aren’t required to follow GAAP or corporate accounting rules, but they do need organized and accurate financial records. Essential bookkeeping practices:
- Track all member contributions and distributions
- Maintain records of operating expenses, loans, capital calls, and interest
- Distinguish clearly between guaranteed payments, draws, and profit allocations
- Maintain updated capital accounts if the LLC is taxed as a partnership
- Retain copies of the operating agreement, major contracts, and tax filings
If the LLC is used for gifting interests or supporting trust distributions, accurate records are crucial for valuation, audit defense, and fair beneficiary treatment. A sloppily run LLC can upend the very structure you built to preserve wealth.
3. Update the Operating Agreement
As the business grows, family circumstances change, or members join or exit, the operating agreement should evolve too. Advisors should recommend a review every few years or sooner if there's a major event (e.g., death, divorce, sale, or liquidity event).
An outdated agreement can invalidate control provisions, create ambiguity around succession, or misalign with the estate plan. Worse, if litigation arises, the outdated agreement becomes the rulebook.
4. File Required Reports and Pay Fees
New York LLCs must file a Biennial Statement every two years and pay a $9 fee. Other states have different annual or biennial filing requirements and sometimes franchise or minimum taxes.
Falling out of good standing can block the LLC from suing, enforcing contracts, or even maintaining banking relationships and may affect valuation or tax status in an audit.
5. Formalize Major Decisions
While LLCs aren’t required to hold annual meetings, it’s smart to memorialize key decisions in writing, especially in multi-member or trust-owned structures. Examples of actions to document:
- Admitting or removing a member
- Making or repaying loans
- Transferring membership interests
- Electing tax status changes (e.g., S-Corp election)
- Amending the operating agreement
An LLC is not a set-it-and-forget-it entity. It’s a living structure that supports the transfer, governance, and protection of wealth. The good news? Proper maintenance isn’t burdensome, it’s mostly about discipline and awareness. But the cost of neglect can be enormous.
Tax Profile & Planning Power
By default, single-member LLCs are disregarded entities, and multi-member LLCs are taxed as partnerships, though they can elect S- or C-corporation treatment. This makes the LLC one of the most tax-flexible structures available and also one of the most technically demanding when used for estate planning.
When taxed as a partnership, the LLC inherits the “complexity and opportunity” of the partnership tax code, as introduced in our general partnership discussion:
- §704(b) economic effect rules
- §704(c) built-in gain tracking
- §754 basis adjustments on transfers or death
- Distributive share planning for income/loss allocations
This structure supports a wide range of sophisticated estate and tax strategies:
- Transferring minority interests to family members or trusts with valuation discounts
- Consolidating and managing family assets across entities or asset classes under one roof
- Coordinating distributions with grantor trust income taxation to optimize income and estate efficiency
- Retaining voting control while distributing economic interests to others
Example: A client contributes income-generating real estate into an LLC, retains full voting authority as manager, and gifts non-voting units to a dynasty trust. This structure supports valuation discounts, asset protection, and multigenerational transfer, all while maintaining full operational control in the hands of the grantor/manager.
Distributions Don’t Have to Be Equal, but They Must Be Defensible
One of the strategic flexibilities of partnership taxation is the ability to allocate income, loss, and distributions in ways that don’t strictly follow ownership percentages. For example, if one member contributed more capital or bears more economic risk, the operating agreement can allocate a larger share of profits, or distributions, to that member.
However, this flexibility is not unlimited. Under §704(b), such allocations must have “substantial economic effect.” That means:
- The allocation reflects real economic risk and benefit
- Capital accounts are maintained properly
- Liquidation follows capital balances
- Deficit restoration obligations or alternative tests are met
Unequal distributions that lack economic substance can be recharacterized by the IRS, potentially undermining both tax and estate outcomes. For LLCs electing S-corp status, this flexibility disappears entirely: distributions must be strictly pro rata, and deviations can jeopardize the S election, a topic we explore more fully in our Corporation Business Entity Selection article.
Contributed Property: Planning with Built-In Gain
In family partnerships and new business ventures alike, it’s common for partners to contribute appreciated assets, real estate, marketable securities, or even an operating business. While this can be an efficient way to centralize ownership or formalize succession, it brings technical baggage the IRS watches closely.
When a partner contributes property to a partnership with a fair market value greater than their basis (i.e., it’s appreciated), the built-in gain must be tracked and preserved. Under IRC §704(c), that gain must be allocated back to the contributing partner if the asset is later sold or depreciated. In a family context, this matters when:
- Parents contribute low-basis property into an FLP or LLC for gifting
- A child becomes a partner and starts receiving allocations
- The property is sold or depreciated later, triggering unexpected gain allocation
Improper handling can result in misallocated tax burdens, especially if generations change before realization.
Hot Assets and Section 751
When a partnership holds assets that produce ordinary income upon sale, such as:
- Depreciation recapture property
- Unrealized receivables
- Inventory-type assets
These are classified as “hot assets” under IRC §751. If a partner sells or gifts an interest, part of the gain may be recharacterized as ordinary income, not capital gain. In the estate planning world, this gets overlooked, but it matters when:
- A parent gifts an FLP interest holding depreciated real estate or a closely held business with built-in receivables
- A buyout occurs, and the exiting partner gets unexpected ordinary income treatment
- A trust inherits and later liquidates the interest, triggering complex tax reporting
Formation of a Business Entity: What’s Really Being Contributed?
In partnerships formed to "hold the family business," it’s essential to define what is being contributed:
- Is it just cash and IP? Or are you bringing over hard assets with depreciation histories?
- Are there contracts, receivables, or embedded ordinary income streams?
- Are you converting a sole proprietorship into a family enterprise and if so, are you accounting for the embedded gain profile of the owner’s balance sheet?
A contribution to a partnership is not a step-up. It’s a carryover basis transaction that keeps all prior gain (capital and ordinary) alive.
Estate Planning Considerations
LLCs are among the most versatile tools in the estate planner’s toolkit. With proper structuring, they can support sophisticated strategies for asset protection, transfer efficiency, and family governance across generations. Strategic Advantages for Estate Planning:
- Valuation Discounts: Non-controlling and non-marketable interests in LLCs can be valued at a discount for transfer tax purposes, especially when paired with restrictions in the operating agreement.
- Control Retention: Through manager-managed structures, senior family members or trustees can retain operational control while transferring economic ownership to younger generations or trusts.
- Asset Segregation & Liability Protection: LLCs can isolate high-risk assets or activities from core family wealth. Real estate, operating businesses, private investments, and intellectual property can be housed in separate legal wrappers.
- Flexible Gifting Structures: LLCs allow for interests to be gifted, sold, or transferred using vehicles such as GRATs, IDGTs, and SLATs, often without triggering immediate tax or control disruption.
- Unified Reporting & Oversight: For large or complex estates, LLCs provide a centralized view of family assets, governance, and distributions, helping advisors and fiduciaries coordinate across multiple trusts or family members.
Layered Structuring: LLCs Within LLCs
Sophisticated estate structures often go further, using multiple LLCs to isolate risk, manage income, and optimize tax treatment:
- A management LLC may receive fees or guaranteed payments for operating services (property management, consulting, etc.), separating business operations from investment returns.
- Rental properties are often held in single-asset LLCs, each owned by a parent holding LLC to protect against cross-liability.
- Family operating businesses may be separated from the real estate they occupy:
- The operating company pays rent to a real estate LLC owned by the family.
- This creates an income stream to different trusts or family members.
- It can support income-splitting, asset protection, and succession clarity.
Example: A family owns a veterinary clinic. The practice is operated through "Main Street Vet LLC," while the building is held in "MSV Realty LLC." Main Street Vet pays market rent to MSV Realty, which is owned by a trust for the children. One child takes over the practice; the other receives passive income from the building, preserving fairness and separating risk from ownership.
Common Pitfalls
Even with all their advantages, LLCs are not plug-and-play. Estate advisors should watch for:
- Poorly Drafted or Outdated Operating Agreements: These are often boilerplate or never updated to reflect family changes, business evolution, or planning goals.
- Failure to Elect §754 After Death or Transfer: Missing this step can lock in unrealized gains and deny beneficiaries a basis adjustment, especially damaging in multigenerational plans.
- Commingling Assets or Accounts: Using LLC funds for personal expenses or failing to separate accounts can expose members to veil-piercing risk.
- No Succession Plan for Managers: LLCs often name the founder as manager but fail to address what happens if they become incapacitated or die, leaving control in limbo.
- Overlooking State Tax Complexity: LLCs holding multi-state real estate can trigger franchise taxes, gross receipts taxes, or income apportionment issues. Advisors need to coordinate with CPAs early.
Advisor Insight
If the general partnership is a relic, the LLC is the renaissance. It's not just a holding entity; it's a design tool. When built with care, an LLC can separate ownership from control, income from operations, and generations from risk. LLCs let families organize around complexity, not be crushed by it.
Conclusion
LLCs and partnerships offer valuable flexibility for business owners focused on long-term planning, ownership design, and tax efficiency. But they aren’t the right fit for every situation. For businesses considering outside investment or future exit strategies, corporate structures may provide better alignment. Learn more about C and S-corporations here.
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