A Series LLC allows the entity’s members to segregate the liabilities, control, and profit sharing of one business conducted by the LLC from another business conducted by the same LLC.
A Series LLC is a special form of LLC that provides for the establishment of designated series within the LLC applicable to specified assets or operations, each with a separate business purpose or investment goal. In a Series LLC, the debts, liabilities, and obligations relating to one series are enforceable only against the assets of that series and not against the assets of the LLC generally or the assets of any other series. Each series can hold its own assets, have its own members, conduct its own operations and pursue different business objectives, but remain insulated from claims of members, creditors or litigants pursuing the assets of or asserting claims against another series.
To date, only eight states -- Delaware, Iowa, Oklahoma, Illinois, Nevada, Utah, Tennessee, and Texas -- have adopted Series LLC statutes, but several others have similar legislation under consideration. Even in those states that have adopted legislation, many questions remain unanswered concerning the new type of entity.
In sum, the Series LLC may offer the advantages of increased asset protection from creditors and the reduction of legal, accounting, and administrative costs and taxes in the jurisdictions which recognize such business entity structure. However, in those jurisdictions which have not adopted legislation allowing for the formation of the Series LLC, there exists uncertainty in the actual level of asset protection offered, as well as the amount of potential tax savings.
Advantages of Using a Series LLC
By establishing a Series LLC to segregate real property (and other) assets and businesses within an LLC, the costs and administrative inefficiencies of establishing separate, multiple LLCs for each property can be avoided. Each specific real property in a multi-state or multi-parcel transaction can be placed into a separate series with liability limited solely to that property. Establishing a Series LLC also helps to minimize initial start-up and formation costs, filing expenses, and state franchise fees and other charges (as well as in some cases, annual maintenance, administrative, compliance and tax costs) that otherwise would be incurred with respect to the establishment of separate LLCs for each property which could amount to several thousand dollars. In general, for Secretary of State filing purposes, the Series LLC is considered one entity that f les a single annual report and pays a single fee. For example, in Delaware, a Series LLC is treated as one entity for franchise tax and registered agent fee purposes, meaning that it is assessed one $250 annual tax and one registered agent fee, rather than the separate tax and fee that would otherwise be applied individually to separate LLCs.
From an asset protection point of view, isolating risky assets and businesses into separate entities away from other assets is always a good idea. The most common use of Series LLCs is for a real estate
holding company with multiple parcels of real estate. Best practices from a legal liability position would be to form a separate LLC for each of the separate properties. This would generally require separate organizational documents, complete with separate articles of organization and periodic reports to be filed with the Secretary of State for each LLC. Filing fees in that situation can add up very quickly, especially if the LLCs also need to be admitted to do business in other states and then need to retain registered agents for each LLC in those other states.
Along came the series LLC. Instead of using with a separate LLC for each parcel of real estate, one Series LLC could be formed with a separate series designated for each parcel of real estate. These series may vary between them as to ownership, profit allocations, distributions, voting rights, and so on. Theoretically, only one Operating Agreement would be needed to govern the rights and obligations between these different series interests. The Series LLC structure provide for the creation of separate protected “series” within one limited liability entity without the need to create separate entities, thus avoiding the inefficiencies and costs associated with multiple related entities. The state Series LLC statutes generally provide that the liabilities of a particular series are enforceable only against the assets of that series.
In general, the state Series LLC statutes allows the LLC Operating Agreement to designate series of members, managers or LLC interests that have separate rights and duties with respect to specific LLC property or obligations. The LLC operating agreement could specifically provide for the establishment of various series with differing members, differing assets, and separate liabilities, with separate “sharing ratios” with respect to the percentages in which the members of a particular series participate and share in certain items, such as cash distributions and the allocation of profits and losses. Separate functions of a business, such as real estate management services on the one hand and rental services on the other hand could be segregated and performed by separate series within an LLC. The Operating Agreement also could provide that a member of a particular series may be a member of another series. In other words, the Series LLC provides a business the flexibility to operate one or more separate divisions or lines of business all under one entity.
An additional use for the Series LLC is to help serve as an equity incentive program in a business with multiple divisions. With each division divided into a separate series, the LLC can give the key employees of each series some sort of equity interest tied to that series only rather than equity interests in the entity as a whole. This is believed to reward employees at successful divisions and protects them from the potential downside of other divisions.
A further use for the Series LLC is to facilitate the combination of business operations of separate businesses. For example, rather than engaging in a traditional merger, two companies wishing to merge might form a Series LLC, with each company contributing its assets to a separate Series of the LLC, or with the owners of each company contributing their ownership interests to a separate Series of the LLC. The LLC Operating Agreement could be drafted to determine exactly which rights and responsibilities are shared and which are maintained separately. The Series LLC provides a very efficient and flexible structure for this sort of business merger.
Disadvantages of Using a Series LLC
Although the Series LLC has become increasingly popular, there is a certain degree of uncertainty surrounding the Series LLC form.
Legal Separation of the Assets and Liabilities under State Law
The legal separation of the assets and liabilities of each series in a Series LLC has not been evaluated in court. Although the state Series statutes generally all provide for legal separation of series, it is unclear whether courts in other states and/or jurisdictions would recognize a legal separation of assets and liabilities within what is theoretically a single entity. Therefore, even if a Iowa Series LLC, for example, were properly operated and each Series of the entity was kept separate with distinct records relating to the assets and liabilities of each series, a court in another jurisdiction could determine not to recognize the legal separation afforded under Iowa law for example. In other words, outside of the states that have specific Series LLC law, it’s not guaranteed that the inter-series liability protection will be respected. In addition, it is unclear how the states with non Series laws will treat Series LLC from an entity prospective for state administrative purpose. For example, although the State of California has not officially recognized the Series LLC from a legal perspective, the California Franchise Tax Board has recognized them from a tax perspective, and has said it will tax each Series individually.
One should generally be concerned about how Series LLCs will be treated by the states that don't have laws permitting them. If, for example, you set up a series LLC in Delaware then register it as a foreign entity conducting business in the state of New Jersey, each series in the LLC own a separate piece of property. If there's a lawsuit in regards to one of these properties you can't be sure that the New Jersey court will honor the series structure of the LLC, applying Delaware's law to the real estate and activities that are located in New Jersey. If they do, the claimant can collect only against the property in that series. If they don't, the claimant can collect against the properties in other series as well. States are expected to give full faith and credit to legislation of other states, but the answer is still somewhat uncertain.
U.S. Federal Income Tax Treatment
Although the formation of Series LLC is currently permissible under the laws of Delaware, Illinois, Nevada, Iowa, Oklahoma, Tennessee, Texas, and Utah, there is a general likelihood that other jurisdiction may not recognize different Series of a LLC as separate and distinct entities. In those jurisdictions that have not adopted legislation allowing for the formation of the Series LLC, there exists uncertainty in the actual level of asset protection offered, as well as the amount of potential tax savings. Moreover, the Internal Revenue Service has not issued a ruling relating specifically to Delaware Series Limited Liability Companies (this entity structure of liability segregation was first approved in Delaware). The Series LLC's line of business and profit and loss sharing arrangements must be examined carefully in each case to determine if the Series within the Series LLC consist of separate businesses, for which separate returns must be filed
In general, the series LLC is not more widely used largely because its tax treatment has not been fully resolved and because its effectiveness has not been tested judicially. Currently, the federal tax treatment of Series LLCs with multiple members remains unclear.
However, on January 18, 2008, the Internal Revenue Service issued Private Letter Ruling 200803004, which ruled that the Federal tax classification (i.e., disregarded entity or partnership or taxable association) is determined for each series independently. Thus, for example, if there is only one owner of series 1, then series 1 can be a disregarded entity (assuming it does not elect to be taxed as an association). And if series 2 has two owners, then it will be treated as a partnership. In addition, it is believed that a series with different members (or the same members but having different interests) is likely to be treated as a different partnership under Federal tax law.
Although Private Letter Ruling 200803004 offered some guidance as to the federal tax treatment of Series LLCs, many states have not provided concrete guidance on the effect of the series distinction for state tax purposes. While states typically follow the federal rules in classifying business entities for state tax purposes, certain states have addressed the classification of series limited liability companies in the absence of formal guidance at the federal level. The California Franchise Tax Board has asserted that each series of a series limited liability company will be treated as a separate entity for California filing and tax purposes. The California Franchise Tax Board's position is premised on series possessing the following characteristics: (i) the holders of the interests in each series are limited to the assets of that series upon redemption, liquidation, or termination, and may share only in the income of that series; and (ii) under state law, the payment of expenses, charges, and liabilities is limited to the assets of that series.