Selecting the right legal structure for your business is one of the most important decisions you’ll make—especially for high-net-worth individuals whose business interests intersect with broader wealth, estate, and tax planning goals. Each entity type, whether a partnership, LLC, S Corporation, or C Corporation, comes with specific tax characteristics that can either support or hinder long-term financial strategies.
Here’s a breakdown of how different business structures are taxed and what those differences mean for successful entrepreneurs and investors.
How Taxation Varies Across Entity Types
Understanding the core tax characteristics of each entity type is essential before comparing the pros and cons:
- Partnerships are pass-through entities—profits and losses go directly to the partners, who report them individually.
- LLCs provide liability protection and offer flexible taxation—they can be taxed as a partnership, S Corp, or C Corp.
- S Corporations are also pass-through entities but have restrictions on ownership and profit distribution.
- C Corporations are subject to double taxation: once at the corporate level and again when dividends are paid to shareholders.
These structural distinctions become even more important when layered with the complexities of wealth transfer planning, risk management, and income allocation among multiple stakeholders.
How Partnerships Are Taxed
Partnerships file an annual informational return but don’t pay federal income tax at the entity level. Instead, each partner receives a Schedule K-1, which outlines their share of the profits, losses, and deductions. That information is then reported on the individual’s tax return.
One important feature is the flexibility in allocating income among partners. The allocation doesn’t have to match ownership percentages if the variation has what the IRS calls “substantial economic effect.” This allows partners to structure financial arrangements around specific roles or contributions.
However, partners must pay close attention to basis rules, which limit how much loss a partner can deduct based on their investment in the business. Partnerships must also adhere to detailed rules around guaranteed payments, capital accounts, and distributions, and are subject to centralized audit procedures under federal law.
Tax Disadvantages of Partnerships
While partnerships offer attractive flexibility, they aren’t without their drawbacks:
- Self-Employment Tax: Each partner is typically liable for self-employment tax on their share of earnings, which includes both employer and employee portions of Social Security and Medicare taxes.
- Phantom Income: Even if a partnership does not distribute earnings, each partner is still taxed on their share of the income. This can create cash flow challenges when taxable income is not accompanied by actual cash distributions.
- Unlimited Liability for General Partners: In general partnerships, personal liability for business debts can be a major risk. This makes it critical to evaluate whether the structure adequately protects personal wealth.
Are Partnerships More Tax-Efficient Than C Corporations?
In many cases, yes. Partnerships don’t pay corporate taxes, so income is only taxed once—at the partner level. C Corporations, by contrast, face double taxation: once on profits and again when those profits are distributed to shareholders as dividends.
Additionally, partnerships can allocate income and loss in ways that don’t necessarily follow ownership percentages. This flexibility is useful in structuring deals where financial contributions or operational involvement vary significantly among partners.
For family businesses and joint ventures with different stakeholder roles, this level of customization can be especially valuable.
S Corporations vs. Partnerships: Which Is Better?
Both S Corps and partnerships are pass-through entities, but the nuances of how each handles compensation and ownership are different:
- S Corps allow owners to draw a salary (subject to payroll taxes) and receive additional income as distributions, which are not subject to employment taxes. This setup can lead to tax savings.
- Partnerships, however, treat all active income as subject to self-employment tax, and they allow greater flexibility in distributing income.
Ownership restrictions also differ. S Corps are limited to 100 shareholders, all of whom must be U.S. individuals, while partnerships face far fewer restrictions on ownership and can accommodate entities, trusts, and foreign individuals.
The choice between these structures often comes down to how you plan to compensate owners and what level of administrative complexity you’re willing to manage.
Why LLCs May Offer More Advantages Than Partnerships
LLCs offer the best of both worlds: the tax transparency of a partnership and the liability protection of a corporation. By default, multi-member LLCs are taxed as partnerships, but they have the option to be taxed as an S or C Corporation if more appropriate for the owner’s needs.
This flexibility allows high-net-worth individuals to tailor the tax treatment to align with broader estate, philanthropic, or investment strategies. LLCs also support unlimited ownership by entities or foreign persons, providing more versatility than an S Corporation, which has rigid restrictions.
In addition, the legal shield provided by LLCs helps protect personal assets, something general partnerships cannot offer unless structured as limited partnerships or combined with other liability-limiting strategies.
Conclusion
No single entity type is perfect for every situation. The best structure depends on a range of factors, including liability tolerance, income goals, capital needs, succession planning, and tax optimization strategies. For high-net-worth and ultra-high-net-worth individuals, the decision is rarely about today’s taxes alone—it’s about aligning the business structure with a broader financial vision.
Working with qualified tax and legal professionals ensures that your entity choice not only meets your immediate needs but also supports long-term growth and wealth preservation across generations.
