On September 14th, the IRS finally issued something we’ve been waiting for … proposed formal regulations on how the Series LLC will be treated for tax purposes. It’s great news – we’ve needed clarity in this area for several years, and it will go a long way towards helping Series LLCs gain in popularity and workability.
This week we’re going to be talking about what those Regulations mean for current Series LLC owners, as well as those who are thinking about starting a Series LLC.
Today we’re going to start with the basics of a Series LLC.
Subsidiaries can have legal liability barrier between main LLC and each other
A Series LLC is a regular LLC, with a special added bonus: the ability to create subsidiaries. Each subsidiary can be operated independently of the main entity. Where the subsidiaries are operated strictly in compliance with state laws, meaning that the subsidiaries are keeping independent records, separate bank accounts, and so on, the subsidiaries get the benefit of legal protection from each other. That means a debt or problem in one subsidiary won’t necessarily affect the others, even if they are all owned by one person. However, to get that inter-subsidiary asset protection, you’ve got to follow state rules. If you have all the subsidiaries operating together, sharing one bank account, comingling funds or otherwise acting as a big LLC, you will most likely find that the structure is collapsed down into one LLC for tax and legal purposes.
A Series LLC is typically created as a Manager-Managed entity, as are the subsidiaries. The Members (owners) can be individuals or other entities. You can have separate Managers and Members for the main LLC and the subsidiaries, as long as everyone agrees.
Subsidiaries also don’t have registration requirements with the Secretary of State, the way that a regular LLC does. That means you’ll have just one payment each year for resident agent and state renewal fees. It’s a great deal! Instead of having 10 LLCs, each holding 1 asset, you could have 1 LLC, with 10 subsidiaries, and each subsidiary holds an asset. Again, if you keep the records separate (the same way you would for 10 LLCs) you’ll get the asset protection you’re looking for, but for the price of just one LLC.
When you want to create a new Series you prepare the paperwork internally. I typically like to use a set of Resolutions, authorizing the creation of the Series and it’s initial Manager(s) and Member(s), followed by a separate set of Resolution of the Series, establishing its own rules of operation. I also use an Operating Agreement for each Series – that’s essential to setting out the structure of how it operates and how it relates to the main Series. Finally, if the Series needs a separate Tax ID number so it can operate independently, I put that in place.
There are 8 states with Series LLC legislation on the books (Delaware, Illinois, Iowa, Oklahoma, Nevada, Tennessee, Texas and Utah). But even if you don’t live or own property in one of those states, you may still use a Series LLC by qualifying it to do business in the state(s) where you want to operate. You will need to qualify the base LLC though. Because the subsidiaries aren’t filed anywhere, there isn’t a way to qualify them individually in a state.
Are there downsides to using a Series LLC? Certainly! Despite state laws being around for 13 years or so, the IRS is only now getting to creating some formal guidelines on how they’ll be taxed and treated under federal tax law. Plus it’s still not clear on how a Series LLC will be treated in a neighboring state that doesn’t have its own Series LLC law.
Other legal issues have also come up, specifically with respect to the ability of the individual subsidiaries to operate independently. And then there’s state tax considerations. California, for example, doesn’t have its own Series LLC laws on the books, but its Franchise Tax Board has created a specific set of rules for how the Series LLC will be taxed. In this case, CA wants to see each subsidiary taxed as a separate structure, paying its own $800/year minimum franchise tax.
Will the Series LLC work for you? That’s a question that everyone will need to answer for themselves, ideally after discussing all of the issues with your tax and legal advisors. You may also be interested in this week’s product special on the Series LLC. We’ve got a 25+ page eBook on the structure, along with a series of 4 audio discussions that take a detailed look at how the Series works, when it works, and when it may be best to stay clear.
Upcoming Blogs This Week
Tuesday: You Should Consider a Series LLC If ….
Wednesday: IRS & the Series LLC
Thursday: California & the Series LLC
Friday: A Series LLC is Smart Business
Well with this clarification I can move a step closer to considering Series LLC’s for my clients. For while I have established some Series LLC’s for a few clients it’s been against my better judgment. Because of a lack of such clarification from the IRS, the courts, and many states the risks have, in my estimation, been too high.
I’ve always felt that an accountant is much like a doctor in that the first rule is to “do no harm”. And while the whole idea of Series LLC’s seems very attractive without a clear understanding of what, if any, the risks were of their separate “subsidiaries” being eventually viewed as one large LLC I could not feel comfortable in recommending them.
This clarification by the IRS begins to answer those nagging questions. Now if we can just find out the remaining questions about how separation will be treated, especially as it pertains to the various states. (A good example being California’s ruling that each “subsidiary” must pay a separate yearly franchise tax.) Far too many of the states that don’t have statues establishing Series LLC’s have failed to make clear their final positions on everything from franchise taxes to their recognition of the separation of the different “subsidiaries” as it pertains to asset protection.
So it is my hope that this move by the IRS to finally resolve some of these critical issues once and for all will now bring movement by the states to make clear their positions on these and other matters.
Of course this still leaves the question of how different states courts will treat these “subsidiaries” in matters such as bankruptcy and contract law. And I would certainly like to see some court rulings on the effect of having contracts between different “subsidiaries” of the same Series LLC for services or investment purposes before establishing any. Would such contracts be viewed as breaking the separation between the “subsidiaries” or can these “subsidiaries” deal with each other under contract and still remain separate. Also can a member of multiple “subsidiaries” have loans and investments in more than one of them without breaching their separation by the possible ruling that it’s a co-mingling of funds and business interests? And even if such loans or investments don’t breach the separation of the various “subsidiaries” does it put an investment at risk of being seen as one large investment to a single LLC?
Let’s hope that soon these and other questions will be resolved so I can in good conscience recommend Series LLC’s to a larger group of clients. Until then I’ll approach Series LLC with great caution.