Regular LLC or Series LLC?

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We had a fantastic response to our webinar for real estate investors, Avoid These 5 Mistakes That Will Blow Up Your Real Estate Deductions. It will be available at this link for the next couple of weeks, along with the special offer of our Real Estate Accountant in a Box program. There were so many listeners with so many questions that we couldn’t fit everyone in, even after spending an extra 20 minutes online! So, this week we’re dealing with the questions that didn’t get answered.

First up was a question about Series LLCs, asking which is better: a Series LLC or a regular LLC. And, of course, the answer is “it depends.” So if you’re looking at this for your own investment or business purposes, let me set out some talking points for you to consider while you work your way through to the answer.

A Series LLC, in a nutshell, is an LLC that is permitted, by state law, to establish subsidiary LLCs, called Cells, under the parent. Depending on state law, each Cell can have separate ownership and management. It can have a separate tax identify from the parent, have its own Tax ID number, file a separate tax return, and have a separate bank account. Most importantly, if you obey state law and set it up right, each Cell will have legislated liability protection from the parent LLC and from other Cells in the Series. All of that, yet in most states you will have just a single resident agent fee and renewal fee each year. Diane often says that a Series LLC may be the last business structure you ever form.

So, when does it work best? I love Series LLCs with real estate. Even if you’re the owner of everything, you can still can separate out a portfolio of properties into multiple Cells in a Series and get asset protection on each one. Now if you have a problem on Property #1, it doesn’t impact your other properties, (unless you’ve connected them together somehow, i.e. Cell #5 guaranteed the loan on Cell #1, therefore Cell #5 can be sued if Cell #1 doesn’t pay). You can create Cells on your own – no state filings required (most of the time) and you can do it quickly.

I also like Series LLCs with a lot of business ventures. Take things like Internet and Affiliate Marketing, for example. These are often places where someone going gangbusters wants to set up additional positions, or maybe hop into a joint venture with someone new. They want a quick way to create a new business structure, but don’t have time to wait, nor do they want to invest a significant amount of money on an idea or joint venture that might not pan out. This is a great place for a Series LLC. They can set up a Cell with a separate tax identity, to hold that new position in their MLM. Or, they can set up a Cell with different ownership, and see if that new JV relationship with a buddy they met in Maui is going to work out. It’s easy, fast and inexpensive.

Where I don’t like using LLCs is in a situation where you’ve got a combination of unfavorable taxation and uncertain state law.

Right now Series LLCs are legal in 9 states, being Delaware, Iowa, Illinois, Nevada, Oklahoma, Tennessee, Texas, Kansas (as of July 1, 2012, welcome Kansas!) and Utah. There are also some “kind-of” states, like Wisconsin and District of Columbia, that have Series LLC law, but it’s not as comprehensive. For example, you can set up a Series LLC in D.C., but the Cells are limited, by law, to not acting independently of the parent LLC, even though the Cells get liability protection from each other. So, if you’re in one of those states, I have no problems using a Series LLC at all. But if you’re not in one of those states, then you have to consider how that state’s law will treat your structure in the event of a lawsuit.

We don’t have any firm law on the issue that decides it one way or another. One school of thought says that a state may ignore the Cells and treat the whole structure like one big happy family for a lawsuit. Another viewpoint says that most of the time states uphold the laws of other states, there’s no reason to think that Series LLC laws wouldn’t be upheld.

Then there are states that want to have it both ways. For example, California doesn’t have Series LLC laws of its own. But that didn’t stop the Franchise Tax Board from issuing a ruling that says if you are the owner of a Series LLC, and either the parent or a Cell has nexus in California, you need to bring the whole structure into the state and voluntarily register every Cell for tax purposes. So … while you’ve got an interesting counter-argument to a claim that CA should treat the structure as one entity in a lawsuit, you’ve also potentially got a HUGE tax bill if you have a big structure with lots of Cells. For that reason I don’t often recommend Californians use Series LLCs.

Then there’s Tennessee, which has enacted Series LLC law. In this case, while you only have to file one Annual Report, keeping those costs down (and at $300 each, that’s not a small thing), the state has also decided that each Cell needs to file a separate Franchise Tax Report, even if they have common ownership (unless the whole thing is rolled up and owned by a Corporation). That’s going to add money to your tax return costs, plus even if the Cells don’t make any money TN still has a minimum amount of franchise tax due of around $100. In this instance, That’s not to say a Series LLC is a bad idea in TN – I don’t think it is at all – but you do have to go in with your eyes open, as far as your ongoing taxes are concerned.

For me, the key is “with your eyes open.” Understanding the pros and cons of your own situation is vital to putting your best tax and asset protection plan into place. What works for your colleague won’t necessarily work for you.

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