Inside the Series LLC Coaching Program

Coaching Program
2010-3
Inside the Series LLC
In 1996 a new kind of LLC was introduced in Delaware. Called a
Series LLC, this new entity offered the same benefits as a regular LLC,
with one, HUGE difference. A Series LLC was permitted to create an
unlimited number of completely self-contained subsidiaries. Under
Delaware law, each subsidiary was given the full legal rights available to
any other formal business structure. Each subsidiary could have separate
owners, separate management, hold title to assets, and operate
completely independently from the others.
More importantly, each subsidiary was granted full legal protection
from the acts and debts of the other subsidiaries. Under Delaware law, a
properly structured subsidiary was legally protected from other
subsidiaries. If one subsidiary became the target of litigation, the others
could not be named in the lawsuit as well, and the assets of one
subsidiary could not be targeted by creditors of another.
Series LLCs also received the same creditor protections that regular
LLCs (and corporations) enjoy. A Series LLC is legally considered to stand
apart from you as the owner, as a separate and distinct legal entity. That
means you won’t necessarily be held responsible for paying the debts of
the Series LLC or any of its subsidiaries, unless you have signed a
personal guarantee. Your financial liability is limited to whatever assets
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 1 of 27
or cash you’ve invested into the entity. The reverse is also true. A Series
LLC is generally safe from your personal creditors. Someone suing you
personally won’t necessarily be able to reach inside your Series LLC and
liquidate business or investment assets.
At the time it was created, the Series LLC was designed for real
estate investors and other asset-rich clients. It provided a way to divide
up asset portfolios safely, and without creating numerous companies. Not
only that, owners stood to save money; in some cases thousands of
dollars per year. Rather than paying multiple set up fees, annual report
fees and resident agent fees each year, a Series LLC owner could look
forward to just one annual report fee and one resident agent charge. In
states with expensive annual filing requirements (in Massachusetts, for
example, the current annual report fee is $500 per business structure),
Series LLC owners can save thousands.
Since its introduction seven more states have enacted Series LLC
legislation. Most states follow the Delaware legislation, although the
Illinois legislation is arguably more complete and deals with more of the
practicalities of running this kind of multi-subsidiary structure. Still other
states are considering changing their own laws to allow Series LLCs.
Texas is the newest state to jump on the bandwagon, enacting legislation
in the fall of 2009. Colorado and Maine may be next, as both states have
draft legislation under review.
The idea of the Series LLC was intriguing for many, but the legal
world moves slowly. (Remember, regular LLCs only came into being in
the United States in 1970). Attorneys, financial planners and tax
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 2 of 27
professionals were concerned, not so much by what the Delaware law did
say, as by what it didn’t say. Could a Series LLC operate in a state that
had not yet enacted Series LLC legislation? Would the inter-cell liability
protections hold up in Court? And, more importantly, how did the IRS
view this structure? A lot of our existing law is based on what has
happened before. But caselaw takes years to develop, and while that’s
happening there is no firm guarantee that a Court will always act a
certain way. Few professionals wanted to put their clients into untested
structures, and no-one wanted their client to become “that test case.”
So, the Series LLC remained on the fringes of asset protection for
several years. But then something interesting happened. Early adopters
of the Series LLC began to explore the possibilities of using the Series LLC
for other things. They began to ask the IRS to clarify how a Series LLC
should be taxed, and more importantly, how the subsidiaries were to be
taxed. A “generally accepted” standard began to emerge. In 2008 the IRS
issued a Private Letter Ruling that stated each subsidiary was permitted
to adopt its own tax classification and this would be upheld as long as
that subsidiary operated independently, and kept separate records.
While things are still developing (and will continue to develop for
years to come), Series LLCs are becoming a safer and more acceptable
business structure across the country. Is it right for you? The answer
depends on your unique circumstances, but in many instances, you will
find that yes, the Series LLC will work, and will save you some money
along the way.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 3 of 27
States that Have Series LLC Legislation
The states that have enacted Series LLC legislation are: Delaware,
Illinois, Iowa, Oklahoma, Nevada, Tennessee, Texas and Utah. That
doesn’t mean you can’t use a Series LLC in another state, but there are
some additional things to consider before you proceed.
Series LLC Preliminaries: Will this Structure Work for YOU?
If you’ve got multiple business operations, then there’s a good chance
that a Series LLC can work for you. This is especially true if you live in
one of the 8 states that recognize the structure. You may also be able to
use the structure successfully even if you live in another state, with some
careful planning.
Here are some of the ways we’ve seen a Series LLC successfully used:
• Real Estate Portfolio: If you have multiple real estate
properties, especially where you’ve got lots of equity, different
types of properties, or properties spread across multiple states,
a Series LLC can be a great way to protect your portfolio,
without setting up multiple LLCs. You can separate out your
real estate holdings in whatever way works best for you. As long
as you’re following the corporate formalities associated with
Series LLCs (separate record-keeping, banking, etc.) state laws
will uphold the liability protection between the Cells.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 4 of 27
• Multiple Businesses: When business opportunities come our way
and you need to move fast, a Series LLC lets you do so. Because
you create subsidiary Cells internally (in most states) you don’t
need to wait for Articles to be filed. You can establish the
paperwork, file for a Federal Tax ID number and get your bank
account opened, all in the same day, with a minimum of time
and little to no expense. This is one way we personally take
advantage of the Series LLC.
• New Business Relationship/Joint Venture: Sometimes you need
to spend some time working with another company or individual
first, on a trial basis, before you enter into long-term
arrangements. Creating a new Cell to hold your ownership in a
joint venture or trial arrangement lets you work with someone,
without risking any of your personal assets or other business
operations. If the relationship doesn’t pan out, the only thing at
risk is the Cell you created.
• Multi-Partner Deals: In this instance we’ve got several people
working together, but who are not all in the same position from
a tax perspective. We see this often when professionals get
together to offer a service under one common umbrella. Having
each professional holding his or her ownership through a Cell
allows each professional to make the tax election that suits him
or her best, while allowing the group to present one united face
to the world.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 5 of 27
• Estate Planning: You can use a Series LLC in the same way you
would divide up assets in a Trust. Divide up your assets into
different Cells, and pass ownership in each Cell through the
trust, to the beneficiary of your choice. Now you’ve got
additional asset protection that a revocable trust alone may not
provide.
Essentially, if you’ve got more than one business there’s a good
chance that a Series LLC can work for you.
Series LLC Basics: Members, Managers and Subsidiary Cells
Members
The owners of a Series LLC are called Members. Like a regular LLC, a
Series LLC may be owned by individuals or other business entities. There
is no geographical distinction on ownership; owners may be located
anywhere in the world, as long as they comply with the entity’s tax
classification.
In a standard LLC, you can choose to operate in one of two ways. You
can operate as a Member-managed LLC, where every Member has an
equal right to operate the business. All Members vote, can sign checks,
make contracts, buy and sell assets in the LLC, and so on. You can also
elect to operate as a two-tier structure, where Members take on the role
of passive, non-participating owners (like limited partners) and the dayto-day operations are carried out by Managers.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 6 of 27
Managers
The Managers are elected by the Members. They can be people, or
they can be other business structures in turn (again, depending on the
tax classification).
Managers are tasked with running the LLC. They control the business
operations; writing the checks, hiring and firing employees, entering into
business deals, signing contracts, and all of the other activities that
make up the daily running of a business. This style of management is
more like the classic corporation management. In fact, if the LLC was a
corporation the Managers would have titles you’re familiar with, like
President, Secretary-Treasurer, Vice-President, General Manager, and so
on.
You can be a Member of an LLC and a Manager. In fact, in most small,
closely-held LLCs this is a typical set-up, where the Managers are also the
Members. But there are times when it’s very convenient to have the twotiered structure. For example, let’s say you want to give some of the
ownership in an LLC to your children, but you don’t want them
interfering in the daily business operations. If you have a single-level,
Member-managed operation, you can’t do this. As full Members, your
kids have the right to vote, and receive their share of the profits. But
once they come of age, they also have the right to sign contracts,
checks, bind the business, and make decisions somewhat independently
of you and the other Members. While your kids probably won’t get the
business into trouble, it’s an unnecessary risk you don’t have to take.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 7 of 27
Another example would be a case where you’ve got a silent partner,
who wants to participate in the profit, and has invested money or assets
into LLC, but doesn’t want to be bothered with the rest of it. By creating
a Manager-managed LLC, with you as the Manager (and a Member) and
your silent partner as just a Member, you have accomplished just that.
(There’s also a really neat tax advantage that we’ll share a little later
on).
In a Series LLC, you always operate in the two-tiered, Managermanaged structure. The complex, layered nature of the structure means
you’ve got to have a centralized point of control, and there’s no better
way to do that in an LLC. This follows through to the subsidiaries, too.
Each subsidiary is also created as a Manager-managed entity.
Subsidiaries (“Cells”)
The ability to have subsidiaries is perhaps the biggest difference
between a regular LLC and a Series LLC. In the states where the Series
LLC is legally recognized, the ability to create an unlimited number of
subsidiaries is set out in the statutes. Each subsidiary (also called
“Cells”) can also choose to operate entirely independently of the Series
LLC. They can have different owners, and different Managers.
Each Series Cell is considered a separate and unique LLC. There is no
legal difference between a Cell and a regular LLC.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 8 of 27
Main LLC
(filed with State)
Series Cell #1
Series Cell #2
Series Cell #3
Created internally
No State Filing
Created internally
No State Filing
Created internally
No State Filing
Typical Structure for a Series LLC
How you establish a Series Cell differs a little from state to state. In
most states where the Series LLC is accepted, it’s a paper transaction.
The Managers of the Series LLC authorize the creation of the new Cell by
Consent Resolutions, and name the initial Managers and Members. A form
is created and attached to the Series LLC’s Operating Agreement, setting
out the details of the new Cell, and a separate Cell Operating Agreement
is created to set out how the Cell will govern itself. The Cell can then
make an IRS filing to obtain its Federal Tax Identification Number,
establish its bank account and begin business operations.
In some states, there may an additional step, whereby you file
documentation with the Secretary of State, notifying the office of the
new Cell. Illinois falls into this category. Illinois, which was one of the
earliest adopters of the Series LLC and is widely considered to have the
most comprehensive legislation regarding the management of the
structure, requires each Cell to be registered with the Secretary of State
and a small fee paid. In fact, under Illinois law, a Cell doesn’t gain
separate and distinct status under the law until it has filed a registration
document.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 9 of 27
In states where you don’t have to register the Cell, you gain some
additional privacy. Without the registration being public knowledge, it’s
much more difficult for someone to find out who owns the Cell and
where it was created.
Series
LLC
Basics:
Naming
Conventions;
Articles
of
Organization; Operating Agreement
Naming Your Series LLC
You will need a name for your Series LLC and each one of the Cells
you are creating during initial set up. All states require you to use the
proper corporate designator after the name of your LLC, which will be
either “Limited Liability Company, LLC, or L.L.C. You will also have to
comply with individual state naming requirements. Usually that means
you can’t use certain words, like “bank”. All states have a list of what is
and isn’t acceptable, typically on their websites or in the instructions
that come with the pre-printed Articles of Organization.
When it comes to naming the Cells, state laws differ. Illinois has the
most stringent requirements. In Illinois, you are required to use the full
name of the Series LLC and then the name of the Cell, e.g., Butterfly
Holdings, LLC – Caterpillar Series. But not all states have this
requirement. Nevada, for example, makes no mention of how the Cells
should be named. For practical purposes, we like to see clients use the
Illinois-style naming convention. Doing business with just “Caterpillar
Series” could be confusing to an arm’s length party who isn’t familiar
with what a Series LLC.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 10 of 27
Confusion in legal terms is always a bad thing. Wherever there’s
uncertainty there’s a potential for a lawsuit, and if a court finds you’re
the one who caused the confusion, you may find yourself losing the
battle. Where the name of a business is concerned that’s especially
tricky. Someone could argue that they thought they were dealing with
you personally, as a sole proprietorship (an entity with no legal
protection whatsoever). That could leave you exposed to personal
liability for the debts of the company – something we don’t want to have
happen to any of our clients!
If you don’t like the idea of using a long company name, you may
want to consider filing a D/B/A application for each Cell. That will allow
you to create a shorter name for everyday use, like company logo,
website, bank account, business card, and so on. But make sure that you
use the longer, formal name when it’s required. For example you
wouldn’t ever want to enter into a contract with a third party without
naming your full structure, e.g., Butterfly Holdings, LLC – Caterpillar
Series, d/b/a The Caterpillar Project.” Now you’ve made it clear to
everyone that there is a legal business entity involved.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 11 of 27
Articles of Organization
A Series LLC is established the same way that you’d set up a standard
LLC. Articles of Organization are filed with the local Secretary of State.
In the states that accept Series LLCs, the format of the Articles differs
slightly from those of a regular LLC, but certain things will remain
constant, including:
• Name of the LLC
• Address of the LLC
• Resident Agent Name/Address
• Designation as Member- or Manager- managed
• Name(s) of the Manager(s)
• Duration of the LLC, i.e., how long do you anticipate the
business will operate (in most states you have the option to
select “perpetual” if you don't have a firm ending date for the
LLC. It’s an outdated requirement, but keeps hanging around)
• Business to be conducted by the LLC (usually a general
statement that the LLC will engage in “all legal business
activities” is sufficient here).
If you are operating in Illinois, you will also be asked to file separate
forms to name each Cell and provide the names of the Managers.
Your LLC is in business once these documents are filed and accepted
by the state, but you’re not done with the set-up yet. Next up is the
Operating Agreement, which is a critical document for your Series LLC.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 12 of 27
Operating Agreement
In any LLC, Series or regular, the Operating Agreement is crucial. The
Operating Agreement defines how your Series LLC is to be structured and
operated. This document sets out the following key points (in addition to
other administrative functions):
• The name(s) of the initial Managers and Members of the Series
LLC
• The names of each Cell being established at the time the Series
LLC is formed (there’s usually at least one, but not always).
• The names of the initial Managers and Members for each Cell
being established
• How new Cells are created or dissolved
• How the Cells relate to the Series LLC, as true subsidiaries or
independent entities
• How the Series LLC Managers are appointed or removed
• How Cell Managers are appointed or removed
• The level of control the Series LLC has over the Cells
• The duties and responsibilities of the Series LLC Managers and
the Cell Managers
• Restrictions on ownership and transfer of Series LLC ownership
• How and in what circumstances Members may be bought out by
the Series LLC, or other Members
• How the profits and losses are to be distributed amongst the
Members
• What happens in the event of bankruptcy in the Series LLC or
any of the Cells
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 13 of 27
• How disputes between Series LLC Managers, Members or both
are resolved
• The level of control Series LLC or Cell Managers have over dayto-day operations of the Series LLC or the Cells, and when
management actions and decisions require pre-approval by the
Members
• How the Operating Agreement may be changed
• When the Series LLC may ask Members for additional cash or
property contributions, and what happens when Members
cannot or refuse to pay
Why an Operating Agreement is So Important
We often see LLCs without Operating Agreements. And, while it’s true
that an Operating Agreement isn’t specifically required by law, there are
some very good reasons why you always want to have one – and why you
particularly want to have one with a Series LLC.
When LLC legislation was first introduced into the United States
(Wyoming was the first state to recognize the LLC, back in 1970) each
state modeled its laws on a uniform piece of legislation. Since then
almost every state has changed up bits and pieces of the original,
uniform legislation to suit that state. We see this especially in the area
of creditor protections, where some states are extremely strong on the
issue, while others provide little to no protection, particularly where an
LLC has a single owner. But one thing that has remained constant across
the board is the subjugation of state law to the language in the
Operating Agreement.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 14 of 27
If you take a look at most state laws, you’ll find language like “Unless
otherwise stated in the LLC’s Articles or Operating Agreement, the LLC
must …” What this means is that if your LLC’s Articles or Operating
Agreement say, for example, that only certain Members may vote, then
only those Members may vote. If voting rights became an issue between
Members, a court or arbitrator would first take a look at what state law
said versus the language in the Operating Agreement. If the Operating
Agreement language was found to be fair and the Members were found to
have consented to the voting restrictions freely, it would be hard to have
that part of the Agreement overturned.
But if your LLC doesn’t have an Operating Agreement, then you’re
stuck with whatever state law dictates. If state law says that all Members
vote equally on all issues in an LLC (unless the Operating Agreement or
Articles specify otherwise), and you don’t have an Operating Agreement,
then all Members vote. You may have had a verbal agreement with your
Members on who can and can’t vote, but verbal agreements are
notoriously hard to prove in court.
You can see how easy it would be to get into trouble without an
Operating Agreement in a regular LLC. Now imagine how that trouble
could be magnified In the case of a Series LLC. The more Cells you
established, especially if you have different management and ownership,
the tighter your Operating Agreement needs to be.
In fact, because each Series Cell is going to operate independently,
we recommend that you create a separate Operating Agreement for each
cell. Remember, the Series LLC’s Operating Agreement deals with the
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 15 of 27
overall operation of the Series LLC. It tells you how you can create and
dissolve Series Cells, but it also allows for each Cell to operate
independently. That means each Cell needs its own guide for how the
Managers operate, what rights the Members have, how profits are
distributed, and so on. Otherwise, you have the same problem – state law
may override your intentions. But the Operating Agreement for a Cell is
usually pretty straightforward and much less complicated than the Series
LLC’s Operating Agreement.
After-Incorporation Issues
Believe it or not, with some help, your Series LLC set-up won’t be that
hard. Chances are you could file the Articles on your own, but you still
may want to ask for help your first time through. We don’t recommend
that you try to create the Operating Agreement on your own, though.
The Series LLC agreement is a specially tailored document that really
needs to be prepared by someone with experience in the area.
However, you can save money when it comes to creating or dissolving
the Series Cells. A reputable attorney or service provider should be
willing to give you the documents you need to start and end the Cells on
your own, without their involvement.
Obtaining a D/B/A for Series Cells
Whether or not you choose to file for a separate D/B/A on one or
more Series Cells is up to you. In states where the Series LLC is an
accepted, legal structure, it may not be strictly necessary, but it may
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 16 of 27
help you out, with banking and licensing. From experience, we’ve found
that using a D/B/A can often help when dealing with government officials
who don’t understand the structure. They see D/B/A’s all the time
though, and often presenting someone with a familiar document will get
you through.
Federal and State Tax Identification Numbers
You can file for federal and state tax ID numbers the same way you
would any other entity. Remember that you will also need to get Tax ID
numbers for each Cell. Even if the Cell is going to be a purely passive
structure it will need a Tax ID number to open a bank account.
Local Licensing Requirements
Licensing requirements vary wildly from state to state, town to town.
Whether or not you need a license often depends on the type of business
being done. In many states, real estate investment entities, or homebased businesses don’t need a license. In others, they do. You may need
a license for the Series LLC, and you may need separate licenses for the
Cells. The best place to start is with your service provider. If you’re
creating Cells on your own, check your local government website to see
if the business activities require you to get a business license. As long as
your entity has a name (or a D/B/A) and at least a Federal Tax ID
number, you should be able to get a license without too much trouble.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 17 of 27
Banking With Your Series LLC
We’ve seen a lot of challenges with banking, even in states where the
Series LLC is legally recognized. Banks have very rigid rules about the
documentation required to establish a bank account. The Series LLC,
with its outside-the-box thinking and naming conventions doesn’t fit
within those rules, especially when it comes to the Cells. The lack of
filed Articles for the Cells is often a problem.
To get around this, you’ll want to do a few things. A good relationship
with a business banker you deal with regularly is a good start. Business
bankers are far more likely to be up on current business-related issues
than personal bankers. Open the initial account under the Series LLC
first, which does have a set of filed Articles. After that’s opened, then
you can usually open the accounts for the Cells using a combination of
the Series LLC’s incorporation number and the individual Cell’s Federal
Tax Identification Number. Make sure you have copies of the Articles,
Operating Agreements and Federal Tax ID number printouts with you, so
you can clearly show how the entities relate to each other.
Also, we’ve found from experience that you will need to keep your
accounts together at the same bank. Opening the Series LLC’s account at
one bank, and then attempting to open a subsidiary Cell account at
another bank is often an exercise in frustration. Even with the paper
trail, you may need patience.
If you find that your bank is stuck on the lack of an incorporation
number, a filed D/B/A/ application can be helpful. You will be assigned a
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 18 of 27
number, and most banks are at least semi-familiar with setting up
accounts using a D/B/A.
Taxation
A Series LLC has the same taxation options available to it that a
regular LLC does. In other words, anything goes. Your Series LLC can
elect to be treated traditionally, as a partnership, (if you’ve got more
than one Member) or as a single member disregarded LLC if you’re the
only member). If your LLC is taxed as a partnership, it will file a Form
1065 partnership return, and flow profit/loss through to the owners on a
K-1. If your LLC is taxed as a single member disregarded entity, it won’t
file a tax return at all, and will just report income and expenses on a
Schedule E (or C) to your personal tax return.
On the other hand, your Series LLC could choose to be taxed as either
a C Corporation or an S Corporation, if that’s a suitable choice for your
business operations. However, that’s not usually our first choice. The
Series LLC is perhaps the ultimate in flexible entities and we’d prefer not
to take away any flexibility at the top of the structure by making an
ineffective tax election. Instead, we typically recommend that the Series
use the default partnership or single-member tax classifications at the
top level, and then make separate elections for each Cell.
This approach works especially well when your Series LLC will be used
to generate both passive and active income. For example, let’s say you
had six rental properties, all generating passive income, divided up into
three Cells. If these Cells were separate LLCs, they would each file a tax
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 19 of 27
return, and pass the net income or loss through to you on a Form K-1
(which gets reported on your personal tax return).
But, even though you would have a separate K-1 for each LLC, the
income they generate will be treated the same by the IRS. With a Series
LLC, properly structured, you could instead have all of these returns
consolidated together in a single return, under your Series LLC. Instead
of 3 separate tax returns, you would have one single return, yet there
would be no impact on your ownership or the liability barriers between
the Cells.
That takes care of your passive income, but what about your other
business activities that are generating active income? You can apply the
same principles. For example, maybe you provide consulting services to
individuals or businesses. The income earned here is treated differently
by the IRS. You could put it into a Cell, but the default taxation wouldn’t
help you here – it would actually increase your taxes. Not a problem. The
IRS permits each Cell to make a separate tax election. You can make the
appropriate IRS filing to have this Cell treated like an S Corporation for
tax purposes. That gives you the ability to establish a payroll under the
Cell, along with all the same tax benefits you’d receive if you had set up
a separate S Corporation. At tax time, this Cell won’t roll up into the
Series LLC with your income properties. It will prepare and file a
separate tax return to deal with its income.
Where you have multiple business operations, you have a choice. You
can operate them through a single Cell, or you can separate those
operations out the same way you would divide up your income producing
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 20 of 27
assets. How you choose to split things up will depend on a few things. For
example, does one of your businesses have a lot of risk associated with
it? If so, it may be better off on its own. Or, perhaps you have several
affiliate marketing sites that you maintain. These are generally low-risk
operations. You are simply providing a gateway through which a buyer
and seller come together, and receive a commission on sales originated
through your website. Rather than starting up several separate Cells, this
may be a situation where you can safely group activities together into a
single structure.
Record Keeping
It’s important to remember that to make your Series LLC work
properly, you need to keep things separated. The legal separations
between Cells permitted by law work only where each Cell is treated as a
separate structure. That means each Cell needs to keep its own
accounting records, have its own bank account, not co-mingle funds with
other Cells, and generally follow all the same rules you would apply to
separately-formed businesses. You don’t need to have separate filing
cabinets for your records, but you do need to be able to prove that you
are following corporate formalities. In fact, you’ll find this requirement
set out in the Series LLC legislation in each state.
Don’t get lazy here. You may be able to consolidate some common
management functions by creating a Management Cell (especially if you
have a Series LLC with multiple Cells that all hold real estate properties),
but you need to have that paper trail available to show to the IRS or your
attorney, in the event of an audit or litigation. If you are using a Cell as a
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 21 of 27
property
manager, collecting rents and paying bills for several
properties from one source, remember to make sure that net profits go
into the appropriate bank accounts at the end of the day.
Where you are operating multiple businesses through one Cell (like
our affiliate marketing example), you may also separate out your
accounting records to track income/expenses for each site. (That would
be good business practice in any event, so you can make sure you aren’t
hanging onto an underperforming site). However, in this case you are
using a single Cell, so depositing income and paying expenses through a
single account is appropriate.
Case Study
After all this talk, how about taking a look at a Series LLC in action.
You’ll find a diagram on the next page. It shows you how a Series LLC
with both passive and active business operations could be set up. We
used two couples here, John and Sue, and Jane and Dave.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 22 of 27
Main Series LLC
•
•
•
•
Filed at the State level
Must maintain a resident
agent
Files an Annual Report
each year
Files a Tax Return each
year
Series Cell #1
Main LLC filed with
State of Illinois, i.e.,
Rainbow Ventures, LLC
(Taxed as a Partnership)
(Files Federal 1065 Return)
(Has EIN for banking, etc.)
Owned by John and Sue
Series Cell #2
Red Lane Series
(owned by Rainbow Ventures, LLC)
(Elects single-member disregarded
entity status, and rolls into Main
Series LLC on consolidated tax return)
Holds an apartment building as a
long-term rental, with about
$500k in equity
White House Series
(owned by John + Dave)
(Elects S Corporation status. John
and Dave take salaries, hire
employees and sub-contractors.
Files Form 1120S tax return)
Rehabs and resells distressed
properties. Typically has 2-3
properties at any one time
Series Cell #3
Manager Blue Series
(owned by Sue + Jane)
(Elects C Corporation status. Sue
and Jane take salaries. Establishes
MERP to cover additional medical
expenses for Sue and Jane (and by
extension, John and Dave). Files
separate Form 1120 tax return)
Provides property management
services to Red Lane Series and
bookkeeping services to White
House Series
This structure gave our owners fantastic flexibility it gave our four
owners. John and Sue are able to keep their apartment building in a
safe, asset-protected structure. The income flows through to their
personal tax return via a Form K-1, where they pay income tax, but no
self-employment tax.
John and Dave are able to operate their secondary business,
rehabbing and selling distressed properties through a Cell that is taxed as
an S Corporation. By using a Series LLC Cell, they also receive asset
protection over the properties they own during the rehab process. In the
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 23 of 27
event John or
Dave is sued personally, the assets held in the White
House are not attachable by a creditor. Likewise, if the White House
Series is sued, perhaps by a sub-contractor or dismissed employee, all of
John and Dave’s other assets are safe. The plaintiff can’t reach across
the line and try and attack John’s apartment building.
The third Cell, Manager Blue Series, also performs an important
function. It allows for Sue and Jane to pull income out of both the Red
Lane Series and the White House Series, lowering the net taxable income
in both structures. Plus, because Sue and Jane are operating the business
as a C Corporation, they can take advantage of all the C Corporation
fringe benefits, like a medical expense reimbursement plan to cover
many qualified medical expenses that aren’t covered under their regular
medical insurance.
And, at the end of the day, our foursome save even more money. If
they had gone to a local attorney or business formation service to
establish these structures, they would have looked at 3x attorney fees,
3x state filing fees, 3x resident agent fees, and would pay 3x again each
year.
Operating in A Non-Series State
So, can you safely operate a Series LLC in a state that doesn’t have
Series LLC legislation? And, if you have a Series LLC set up in one state
and want to register it to do business in another state, can you? The
answer is definitely “it depends.”
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 24 of 27
Taking a Series LLC into another state is pretty straightforward. The
first step is to register the Series LLC into that state as a foreign entity.
This step needs to happen whether you are intending to operate the
Series LLC itself or one of the Cells in that state. Without that
registration, you don’t really have any legal standing in the state, and
you could find yourself paying fines or penalties for failing to register. As
there isn’t a way to register a Cell on its own, you will need to register
the entire entity.
This can cause a problem if you are dealing with a state like California
that has very aggressive tax collection policies. California doesn’t have
enacted Series LLC legislation on the books, but that hasn’t stopped the
Franchise Tax Board from issuing a ruling on how it will tax Series LLCs.
In California, the registration of a Series LLC into the state triggers an
automatic requirement for the owners to register both Series LLC and
voluntarily register all of the Cells for tax purposes. California will then
proceed to collect the minimum $800/year franchise fee on the main
Series LLC and each registered Cell.
So far California is the only state that we’re aware of that takes such
an aggressive stance. However, that’s not to say other states won’t
follow suit, especially in today’s shrinking economy, when broke states
are looking for anything to keep their budgets afloat.
For this reason, we’ll want to take a close look at your circumstances
before recommending you use a Series LLC in California, especially if you
aren’t a California resident. You may be much better served by setting
up a regular LLC in California to provide those in-state services in a
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 25 of 27
closed entity, rather than opening up a large, complex Series LLC to
unnecessary tax.
But perhaps the biggest question surrounding Series LLCs is the issue
of liability and the inter-Cell protection. What will Idaho do with your
Iowa Series LLC, in the event that you are sued in Idaho. Will it respect
Iowa laws, and allow you to maintain the division between Cells? Or, will
it look at your Series LLC as one big LLC, collapsing the Cells into the
main structure and thus putting all of your assets at risk? And, what
happens in the event of a bankruptcy?
The answer you get is also going to depend on who you ask. Many
attorneys feel that a state will apply its own laws first, and that they
have no real interest in putting the laws of another state first. They feel
this is especially true if you haven’t made it clear to your vendors,
business associates and those you contract with that they aren’t dealing
with XXX LLC – they are dealing with a subsidiary Cell of XXX LLC.
Remember, where there is legal confusion (especially in contract law),
the courts usually come down in favor of the party who DIDN’T create
the contract.
And that could very well be true. So far, the issue hasn’t been firmly
decided by the Courts one way or another. We haven’t seen litigation on
that specific issue. However, we have seen litigation and IRS rulings on
other issues involving Series LLC in non-Series states. So, it stands to
reason that state courts are aware of the existence of the Series LLC,
and haven’t seen fit to send clear messages saying “You aren’t welcome
here.”
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 26 of 27
We also don’t have any firm guidance from the bankruptcy courts on
how a Series LLC will be treated. It seems logical that if the Cells are
properly following corporate formalities, then they should be treated by
the bankruptcy court as separate entities in the event of a bankruptcy.
This is especially true if you live in a state that has enacted Series LLC
legislation providing those rights under law. But there’s no firm
guarantee at this point whether that will happen, or whether the
bankruptcy court will ignore the Cell and only consider the entire LLC.
As always, you need to take a close look at your situation, consider
both sides of the argument and make the choice that lets you sleep
peacefully at night.
For more information on the Series LLC, including costs for formation
and preparation of the initial Series Operating Agreement, please contact
Megan Hughes, at Business First Formations, Inc. We’re also happy to
answer general questions about the Series LLC over at the USTaxAid.com
Forum.
© 2010, US TaxAid Series and Smart Money, LLC
All rights reserved
Page 27 of 27