Series LLC: Advanced Form of Business Organization
What is a Series LLC?
Series Limited Liability Company (LLC) is a business entity that was introduced by the State of Delaware nearly nine years ago. The concept is innovative and based on the fact that several series or “cells” may be created within a single LLC. Basically, a Series LLC possesses the ability to divide its assets and liabilities into various sub-LLCs or series while still controlling them from one umbrella company. The closest analogy in the business world would be a corporation with several subsidiaries.
What are the advantages of a Series LLC?
A Series LLC eliminates the expense and administrative duties related to forming multiple LLCs. A Series LLC is preferred to a corporation with subsidiaries because it does not have the taxation, expense or formalities associated with a parent-and-subsidiary corporate structure.
Each cell in a Series LLC has its own profits, losses and liabilities and is legally separate from the other series. These sub-LLCs also have their own economic structures, members, managers and assets. The assets in a sub-LLC are protected from legal enforcement against the assets of another LLC.
Another, lesser-known advantage is that a Series LLC may not be required to pay sales tax on rent paid by the operating series. The business must own the real estate and the rent must be paid to the sub-LLC owning the real estate series. In this respect, the Series LLC may also be compared to an S-Corporation with Q-subsidiaries.
What States Currently Offer the Series LLC Option?
Though Delaware was the first to form the Series LLC, other states are also adopting the practice. Currently, District of Columbia, Illinois, Iowa, Kansas, Minnesota, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah, Wisconsin and Puerto Rico also allow the formation of Series LLC.
How to Form a Series LLC
Forming a Series LLC is similar to forming an LLC or corporation in any state. Today, only Illinois requires a different application and charges higher registration fees for forming a Series LLC rather than a simple LLC.
Once the company is formed with the state, a Series LLC will require some extra documentation compared to an LLC. A 50 or more page Operating Agreement must be prepared to establish a Series LLC. This document must be signed and created according to the rules and regulations governing the Series LLC. In most instances, an attorney is needed to draft the Operating Agreement and an accountant will be needed to explain related tax laws governing the Series LLC.
Each sub-LLC will have to create a separate Series Agreement. Each sub-LLC will have its own asset name, bank account and a separate EIN (Federal Tax ID) number. While the Operating Agreement will be amended as series are added or deleted, the Certificate of Formation (also called Articled of Organization) filed with the state does not require amendment.
How to Add and Delete a Series
A series may be added or deleted by amending the Series Operating Agreement. The Series LLC members must sign an Addendum to the Operating Agreement and then separate accounts must be established and records maintained for the new cell.
In Delaware, a sub-LLC only requires approval by 66% of the owners of a Series LLC.
Deleting a sub-LLC from the umbrella company requires a similar procedure, along with a proper liquidation of its assets and liabilities.
Requirements for Forming a Series LLC
Each sub-LLC should maintain a separate bank account. If there is real estate purchased by a sub-LLC, all deeds should be in the name of the series or sub-LLC (for example ‘SuperCompany, LLC – Green Series’). This should be designated on the document to avoid confusion. All contracts, loans and other notes should also be designated in this format as well. If there are any transactions between series, they should be conducted as though they were an outside entity. For instance, when involved in a real estate transaction with a sub-LLC, the deal should be negotiated at fair market prices according to current appraisal values. All loans between sub-LLC have to be interest-bearing and properly documented.
All assets and operations should be kept separate from other sub-LLCs. Each asset should only be owned by one sub-LLC or series. For example, the same property cannot be owned by more than one series. Each sub-LLC should have enough capital to support itself apart from the other sub-LLCs (a series cannot be undercapitalized).
It is advisable for each sub-LLC must apply for its own ‘doing business as’ name (sometimes called a DBA, a fictitious name or an assumed name). The DBA records should indicate the owners of the sub-LLC. This alerts all interested parties, including creditors, as to which sub-LLC is responsible for any assets or debt accrued. The fictitious name should be obtained in the state or county where the property is owned or the assets of that particular sub-LLC reside.
Only one registered agent and a single annual report are generally required for a Series LLC.
Issues with Series LLC Formation
Currently, governing bodies have not resolved the problems surrounding tax and creditor issues related to the Series LLC. There is some conflict between the Federal Bankruptcy Code and the State Series LLC law. Some current Series LLC owners have expressed concerns about their inability to file one tax return for all of the sub-LLCs. Many attorneys are reviewing the tax laws to determine the best way to resolve tax issues. The resolution will also determine whether or not they will endorse the Series LLC nationwide. However, a pending IRS regulation may solve at least the federal taxation questions related to Series LLC. It is expected to be enacted in the near future.
In California, where Series LLC is not officially recognized, each sub-LLC must file separate state tax returns since it is considered a separate LLC. This process usually requires its own Form 568 Liability Company Return of Income. Each sub-LLC must also pay its own separate LLC annual tax and fee. In Delaware, however, where the Series LLC originated a Series LLC is considered a single entity for state tax purposes. An experienced professional tax consultant should be consulted to avoid problems associated with a Series LLC tax return.
Some professionals have agreed that California’s interpretation of the tax law for Series LLC may be the most prudent way to handle taxes. However, their interpretation does not allow the tax benefits that were initially proposed by the formation of the Series LLC in Delaware. This fact is preventing the concept from being adopted nationwide.
Investors are advised not to group high liability assets with low liability assets in a Series LLC. High liability assets are defined as active businesses, and low liability assets are defined as real estate. This practice is not recommended even if the assets are in separate sub-LLCs.
Who Will Benefit from the Series LLC?
The Series LLC is preferred by savvy investors or ambitious entrepreneurs. Many business owners use Series LLCs as planning tool for venture capital funds, hedge funds, oil and gas deals and fractional share arrangements. Such complex business arrangements often use the series LLC as a management tool. The concept may also be used for Mutual Funds to avoid filing more than one application for separate classes of funds with the SEC. The Series LLC is also useful for entrepreneurs with multiple business ideas or for franchise businesses. Many companies may also use a Series LLC to establish incentive compensation for employees, to own intellectual property or for real estate investments. This concept may also be used as a part of family gifting.
Real Estate investors with multiple properties often use the Series LLC to isolate each property and the liability associated with it into a separate sub-LLC. To save on annual filing fees, the Series LLC may be registered as a single foreign entity in the states other than its home state. This practice is common among entrepreneurs who use Series LLCs to own properties in New York, Texas and California.
LLC vs. Corporation
Comparison Between LLC and Corporation
The following table gives side-by-side comparison of 3 most common forms of business organization: C-Corporation, S-Corporation, and LLC (Limited Liability Company):
NOTE: LLC is the most flexible type of business entity thanks to the fact that LLC members can keep the company taxed as partnership (or disregarded entity if single-member LLC, both default forms of taxation), or instead elect it to be taxed as S-Corporation or even C-Corporation, if company owners’ taxation goals work best with these types of taxation.
Any corporation is taxed as C-Corporation by default, and can be elected to be taxed as S-Corporation, provided all shareholders are U.S. persons, etc (read here for a list of requisites for S-Corporation).
In the table below we compare LLC taxed as partnership (or disregarded entity) with corporations taxes as S-Corp and C-Corp respectively.
|Type of Ownership:||Membership Interests. May be different classes of membership. Owners called “Members”.||Stock, but only one class. Can have voting and non-voting. Owners called “Shareholders”.||Stock. There may be different classes. Owners called “Shareholders”.|
|Eligible Owners:||No restrictions.||100 shareholder limit. No non-individual and no non-resident alien shareholders.||No restrictions.|
|Management:||Managed by members or designated manager(s).||Directors and officers.||Directors and officers.|
|Transfer of Ownership:||There maybe restrictions under certain state laws.||Shares can be transferred only to eligible S corporation shareholders||Shares freely transferred.|
|Tax Rate:||There is no tax to the LLC on LLC income. All profits or losses pass through and are taxed to the members.||There is no tax except in two limited circumstances: (1) recognized built-in gains and (2) excess passive income.||Gradual tax rates from 15% up to 39% apply to taxable income. Personal Service Corporations are taxed at 35% of all income.|
|Tax Upon Sale:||Single tax at member level upon sale of appreciated assets. Generally, no tax on distribution of appreciated assets.||Single tax at member level. Potential built-in gains tax if corporation had appreciated property at time of S corporation election.||Potential double taxation. Corporation is taxed on sale of assets, shareholders taxed on dividends or capital gains tax.|
|Fringe Benefits:||Members are ineligible for certain ones.||Shareholders with 2% and less are ineligible for certain ones.||Shareholders-Employees are eligible for most.|
|Pass Through of Losses:||Losses passed through to members, subject to certain restrictions.||Losses passed through to shareholders, subject to certain restrictions.||Losses not passed through.|
|Fiscal Year:||Must use tax year of members having a majority interest in the LLC, or the tax year of all principal members if there is no majority member.||Must use calendar year, subject to certain exceptions.||May use any fiscal year. Personal Service Corporations must use a calendar year, subject to certain exceptions.|
|Liability of Owner:||There is limited liability for owner(s) and manager(s).||There is limited liability for shareholders, officers, and directors.||There is limited liability for shareholders, officers, and directors.|
|Duration:||Dissolves at the time specified in the Operating Agreement or upon the loss of a member unless other members agree to continue.||Indefinitely.||Indefinitely.|
Quick Comparison: LLC vs. C-Corporation
The entities are taxed differently.
By default an LLC is a pass-through tax entity, meaning that the income is not taxed at the company level (however, a Multi-Member LLC is still required to complete a separate tax return). The income or loss as shown on this return is ‘passed through’ the business entity to the individual members, and is reported on their individual tax returns.
C-Corporation is a separately taxable entity, and pays tax on the income prior to any dividend distributions to shareholders. If and when corporate earnings are distributed to shareholders in the form of dividends, the corporation does not receive the reasonable business expense deduction, and dividend income is taxed as regular income to the shareholders.
The entities differ in their structure.
LLCs are less rigid in their structure than corporations, so you have more flexibility in adapting the LLC to your unique business. The Operating Agreement of an LLC can be structured in a limitless number of ways.
A corporation is a formal entity with officers and directors (at least one of each) required. An LLC, on the other hand, can be ‘member managed’ and run in a less formal way. For small, start-up businesses, less formality means you can focus on making money rather than administrative work.
Quick Comparison: LLC vs. S-Corporation
Difference in income allocation:
While S-Corporation special tax status eliminates double taxation, it lacks the flexibility of an LLC in allocating income to the owners. An LLC may offer several classes of membership interests, while an S-Corporation may only have one class of stock.
Any number of individuals or entities may own interest in an LLC. Also, LLCs are allowed to have subsidiaries without restriction. Ownership interest in an S-Corporation is limited to no more than 100 shareholders. On top of that S-Corporations cannot be owned by C-Corporations, other S-Corporations, many trusts, LLCs, partnerships, or non-resident aliens.
One advantage of S-Corporation is the way self employment taxes are calculated. S-Corporation owners employed by the company must receive salary, and their self employemnt tax is caluclated based on that salary (this is true with the exception of S-Corporations based in New York City). Owners of LLC, on the other hand, pay self employment taxes based on all member distributions they receive.
Quick Comparison: C-Corporation vs. S-Corporation
All corporations start as C-Corporations and are required to pay income tax on taxable income. An C-Corporation becomes a S-Corporation by completing and filing federal form 2553 with the IRS.
An S-Corporation’s net income or loss is ‘passed-through’ to the shareholders and are included in their personal tax returns. Because income is NOT taxed at the corporate level, there is no double taxation as with C corporations.
Difference in income allocation:
Subchapter S-Corporations, as they are also called, are restricted to having no more than 100 shareholders, and cannot be owned by C-Corporations, other S-Corporations, many trusts, LLCs, partnerships, or non-resident aliens.
Choosing Business Entity
Which Business Entity Is Right For Me?
Once decided to become involved in a new business venture, how would you know which legal entity is the right for you? The choice of entity would influence many aspects of the life of your business, from taxation to limiting liability, and more.
Let’s start by reviewing the most common types of entities, available for people doing business in the United States:
Sole Proprietorship & General Partnership
A sole proprietorship is a type of business entity which is owned and run by one individual and where there is no legal distinction between the owner and the business. General Partnership is similar to Sole Proprietorship, except it is owned and run by two or more partners.
All profits and all losses accrue to the owner(s) (subject to taxation). All assets of the business are owned by the proprietor (or the general partners), and all debts of the business are debts of the owner(s) and must be paid from owner(s)’ personal resources, meaning that the owner(s) has unlimited liability.
A sole proprietor may do business with a trade name (DBA) other than his or her legal name. This also allows the proprietor to open a business account with banking institutions. It is a ‘sole’ proprietorship in the sense that the owner has no partners. General Partnership usually does business under a trade name as well.
Establishing a sole proprietorship is cheap and relatively uncomplicated. You don’t have to file any papers to set it up – you create a sole proprietorship just by going into business. In other words, if you’ll be the only owner of the business you’re starting; your business will automatically be a sole proprietorship, unless you incorporate it or organize it as an LLC. Of course, you do have to get the same business licenses and permits as any other company that goes into the same business. It is also advised to register a DBA (‘Doing Business As‘) name with the state for your business.
General Partnership is established by drafting a partnership agreement and obtaining EIN for tax purposes. Registering a DBA is advisable in order to be able to legally operate under the chosen business name.
+ One takes all the profits of the business – no corporative taxes on the profits made,
+ No double taxation,
+ Easy to start up,
+ Relatively fewer regulation,
+ Full control over the business,
+ Easy to discontinue,
+ Quick decision process.
– Unlimited liability – owner(s) of the business is (are) responsible for the business’s debts,
– If business becomes successful, the risks accompanying the business tend to grow,
– Hard time raising capital – owner(s) have to make up for all the business’s funds,
A corporation is a type of business entity that is organized under specific provisions of the General Corporation Law. A corporation must have shareholders, directors and corporate officers, and must be registered with the state. In addition, the corporation will be taxed at the state and Federal level on its earnings.
A corporation offers the protection from personal liability for the owners (shareholders). This ‘corporate veil‘ of protection does not offer protection from liability in the case of fraud, failure to pay taxes, under capitalization of the corporation, or commingling of personal and corporate funds.
The “C” part of “C Corporaiton” refers to the designation of the corporation for tax purposes. Most major companies (and many smaller companies) are treated as C corporations for Federal income tax purposes. Keep in mind, since “C Corporaiton” is a tax designation, and not an entity type, some entities other than corporation (such as LLC) can elect to be taxed as “C Corporation”. For corporations “C Corporation” is a default designation, and does not require any additional filings with the IRS or the state.
+ Limited Liability – owners of the business are not personally responsible for the business’s debts,
+ A corporation may qualify as a C corporation without regard to any limit on the number of shareholders, foreign or domestic.
– Double taxation – C Corporations are subject to corporate taxes, therefore creating the effect of double taxation (first on corporative level, and then on shareholders’ personal level).
Click to learn more about C Corporations.
Similar to the C Corporation, S corporation offers all the benefits of a corporation, but with a different tax structure. S Corporations, much like sole proprietorships and partnerships, pay no corporate income tax. S corporation’s shareholders report the company’s income or losses on their personal tax returns.
To elect your corporation to be taxed as S Corp you need to file S Corporation election with IRS and some states.
One of the biggest differences of S Corp tax designation over disregarded entities and partnerships is in the way payroll and self employment taxes are paid, which could result in tax savings. Despite the obvious tax benefits, S Corporation comes with several restrictions. Major restrictions are:
– Can’t have more then 100 shareholders,
– All shareholders must be physical persons – or simply put, real persons, not corporations, partnerships, etc (there are few exceptions for non-profits and trusts),
– All shareholders must be U.S. citizens or residents,
– Must have only one class of stock.
Click to learn more about S Corporations.
Limited Liability Company (LLC)
LLC combines the limited liability protection of a corporation (hence the name) with the flexibility and pass through taxation of a partnership/sole proprietorship. Like the shareholders of a corporation, the owners (members) of an LLC are not personally responsible for the debts or liabilities of the LLC.
The LLC has no limitations on who may be involved, and it can be managed by its members or by managers. It is often more flexible than a corporation and it is well-suited for companies with a single owner.
+ Limited Liability – owners of the business are not personally responsible for the business’s debts;
+ No limits on number of members;
+ Flexibility in tax designation – LLC can be taxed as disregarded entity/partnership (default), or as S Corp or C corp (requires filing additional election documents with IRS and some states);
+ No double taxation, when elected to be taxed as disregarded entity/partnership, or S Corp.
– In some states (e.g. New York, Illinois) more expensive to form and/or renew than corporation;
– If your business is looking for major investment, your investors might be reluctant to invest in an LLC.
Click to learn more about Limited Liability Companies.
So Which Type of Entity Is Right For Me?
The answer to this question depends strictly on your specific needs and circumstances. We always recommend our clients to discuss your personal situation with a professional CPA or business attorney, however, it is equally important to educate yourself prior to scheduling appointments. After all, it is your business.