Tax Analysts Blog

Series LLCs: The Next Generation of Passthrough Entities?

Posted on Feb 12, 2015

Passthrough entities have received a lot of attention lately -- partially because 90 percent of businesses are structured this way. Most of these businesses are S corporations, limited liability partnerships, or sole proprietorships. Given that so many businesses are being formed outside the C corporation structure, it’s little wonder that tax practitioners and tax administrators are taking a close look at them. So when Bruce Ely, a partner with Bradley Arant Boult Cummings LLP and a well-respected tax practitioner, dubs series LLCs the “next generation” of passthrough entities, it’s time to brush up on series LLC fundamentals and explore both the benefits and risks of those structures.

Series limited liability companies have become popularin recent years and are now used in a variety of business settings to separate the assets and liabilities of a business's different divisions. Series LLCs have proved useful with fractional shares and for investment arrangements. Hedge funds, venture capital funds, and real estate investors frequently look to a series LLC entity to segregate different types of assets in different series.

A series LLC is a special form of LLC that consists of a master LLC and separate subunit divisions (or series). A series LLC is similar to a series trust, which is composed of multiple subtrusts, each of which has its own assets and streams of income. In general, series LLC statutes allow an LLC to be subdivided into separate series of members, managers, LLC interests, or assets that have separate rights, powers, or duties regarding some assets. As a result, each series will have different assets, economic structures, members, and managers. Liabilities and obligations incurred by one series will not jeopardize assets held by or allocated to other series.

Series LLCs cannot be formed in every state, because they are a legislative creation and must be authorized by state statute. Delaware was the first to enact a series LLC statute. In 1996 it amended its Limited Liability Company Act to permit an LLC agreement to establish "one or more designated series of members, managers, LLC interests or assets." The LLC agreement may establish classes or groups of members or managers associated with a series, make provision for future creation of additional classes or groups of members or managers, and authorize other actions.

One of the main benefits in choosing a series LLC is that it offers separate liability protection for each series. If the series LLC satisfies the statutory formation requirements, debts and liabilities of one series are theoretically enforceable only against that series. That means the owner of an LLC with multiple lines of business can put each business line into a separate series and protect the asset of each series from the creditors of assets in other series. Despite being formed as a single entity, each series is generally treated as a separate entity for state law purposes. However, as discussed below, that does not mean that each series is treated as a separate entity in every state or for state or federal tax purposes.

Separate liability is a significant benefit. To obtain the same protection without a series LLC structure would require the establishment of multiple LLCs. Setting up numerous legal entities can be costly because of filing fees and is arguably inefficient compared with the creation of a series LLC. For example, the formation of a series LLC requires less paperwork because it can be done with a single state filing. Once the series LLC is formed, members can create new series by adding an addendum to the series LLC operating agreement; no additional filings are required.

Despite the lure of liability segregation and ease of formation, there are some significant risks in using a series LLC. First, it is unclear whether the separate liability protection will be upheld in non-series-LLC states. If a series LLC is formed in Delaware but has property in Ohio, a non-series-LLC state, it is unclear whether Ohio will recognize the series structure for purposes of asset protection. Ohio may recognize the series LLC, but it is not required to recognize the series LLC structure or the separation of assets and liabilities.

The series LLC structure has also not been well tested in bankruptcy proceedings. It is unclear what happens when one series files for bankruptcy or whether a bankruptcy court will honor the liability shield of that series. The problem stems from uncertainty over the interaction of bankruptcy law with state series LLC laws. Several states, including Delaware, treat a series as a person, so that the series is a legal entity separate from the master LLC that can enter into contracts, buy and sell property, sue and be sued, and arguably file for bankruptcy. However, not all state series LLC statutes clearly distinguish a series as a person.

That designation is important because the bankruptcy code requires that a person file for bankruptcy. However, while the bankruptcy code definition of person specifies that the term includes individuals, partnerships, and corporations, it does not mention LLCs or series LLCs. Although LLCs are generally treated as persons by bankruptcy courts, whether an individual series is a person has not yet been determined in court. As with recognition of the series structure, even though state law may define a series as a person, a federal bankruptcy court is not required to follow state statutes.

Series LLCs are a unique entity type and will likely grow in popularity when states provide guidance on how they will be taxed. Ely said states are awaiting finalization of Treasury’s proposed series regulations. The regulations are expected before the end of July. When that happens, taxpayers will likely feel more confident about exploring the benefits of series LLCs without fear of the consequences.

Read Comments (2)

Bruce ElyFeb 11, 2015

Cara-- we urge caution at this point since only 11 states officially recognize
series LLCs, the Treasury Dept./IRS is dragging its feet on finalizing the
proposed regs, and of course, the states are reluctant to rule on how these
entities will be taxed for various SALT purposes until they see some definitive
guidance from Treasury.

Joe ManjarrezFeb 26, 2015

how about a list of states that authorize these series LLCs

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