Evaluate whether your family investment structure still supports your tax, governance, investment, and succession planning goals.
We recently reviewed a family investment structure that had been formed as a limited liability company (LLC) years earlier. The original decision made sense at the time: the family wanted liability protection, flexible governance, and pass-through income tax treatment.
Over time, the LLC began receiving significant California-source gross receipts from underlying real estate investments. When the California LLC fee was calculated, the amount due was much higher than expected.
That prompted a simple planning question: Why was the holding company structured as an LLC, and does that structure still make sense today?
Understanding California’s LLC fee
California is a useful example of how a federal tax choice can create state-level costs that were not obvious when the entity was formed.
In addition to its annual LLC tax, California imposes an LLC fee based on California-source “total income” under Revenue and Taxation Code Section 17942. Because the calculation starts with gross income concepts rather than taxable income, an LLC can owe a meaningful fee even when cash is not distributed to the members.
The issue often surfaces when significant allocations flow from real estate partnerships, operating businesses, private funds, and joint ventures. Tiered ownership can change the calculation. California provides rules intended to prevent certain double counting in tiered LLC structures, but the result depends on the ownership chain and how each entity is classified for tax purposes.
LLCs and LPs: Which entity structure fits your family’s goals?
The point is not that one structure is better in every case. The better question is which structure best fits the family’s investment strategy, governance goals, tax profile, and succession plan.
Limited liability companies
LLCs remain common for family investment vehicles because they offer liability protection, operational flexibility, customizable governance, and relatively straightforward administration.
They can support a range of economic and management arrangements. The state tax cost, however, may increase as activity grows.
Limited partnerships
Limited partnerships continue to serve an important role in family wealth planning. An LP creates a clearer distinction between management and ownership: general partners manage the entity, while limited partners generally hold passive economic interests. That structure can help centralize control while facilitating ownership transfers across generations.
In California, LPs are not subject to the LLC fee imposed under Revenue and Taxation Code Section 17942, which may create planning opportunities in the right facts. The evaluation still needs to consider liability protection, governance objectives, administrative requirements, state tax exposure, and succession planning.
Family limited partnerships are also frequently used in estate and gift planning, where valuation discounts may be available when supported by the facts and a qualified valuation analysis.
Tax planning beyond California
Other states can create similar economic pressure in different ways.
In Texas, the “franchise tax” applies to many taxable entities “doing business” in the state, including LLCs and limited partnerships. It is based on “taxable margin,” which generally begins with total revenue and then applies one of several statutory computations.
The mechanics differ from California’s LLC fee, yet the planning lesson is similar. Revenue streams, entity classification, sourcing rules, and tax-base calculations can create costs that do not track cash distributions.
The Texas Comptroller describes several ways to compute taxable margin, including calculations based on total revenue, total revenue less compensation, total revenue less cost of goods sold, or total revenue less $1 million. For certain investment vehicles with Texas activity, total revenue can be an important starting point in determining the state tax base. However, the Texas franchise tax doesn’t apply to many types of activities that are operated within certain entity structures such as “partnership passive entities.”
The broader lesson extends beyond California and Texas. States take different approaches to taxing entities (including providing exempt status based on the type of entity or its activities), sourcing revenue, and imposing filing obligations. Those differences can affect after-tax returns when a portfolio expands across multiple jurisdictions.
Entity choice should be revisited as part of ongoing tax planning, not left to the original formation analysis.
Considerations for family investment vehicles
A periodic review should focus on questions that affect cost, flexibility, and future transfers:
- Have state tax consequences been modeled alongside federal tax results?
- Does the current structure support the family’s investment strategy and governance objectives?
- Are administrative requirements aligned with the family’s long-term needs?
- How will future ownership transfers affect tax basis and depreciation opportunities?
- Will future gifting strategies benefit from the existing entity design?
- Does the structure still make sense as activity expands into additional states?
Limited liability company and partnership-based structures may offer meaningful advantages for long-term real estate ownership because they can access basis adjustment provisions under Sections 734(b), 743(b), and 754. These rules may create additional depreciation opportunities or reduce future gain recognition after certain transfers, sales, or estate events.
Corporations, including S corporations, do not have access to those partnership-specific basis adjustment provisions. For real estate-oriented family investment structures, that distinction can be important for long-term ownership, succession, and exit planning.
How CLA can help
Family investment vehicles can generate more state-tax exposure than expected as passthrough gross receipts increase. A periodic review can help identify tax costs, planning opportunities, and governance issues before they become harder to address.
CLA helps families, family offices, and real estate owners evaluate whether existing holding structures still support their investment, governance, tax, and succession objectives. That review may include modeling state-level tax exposure, evaluating tiered ownership, comparing LLC and limited partnership alternatives, and preserving partnership basis adjustment opportunities.