Understanding the Series LLC
What is a Series LLC?
A series LLC is a limited liability company where each series acts as a separate LLC for liability protection purposes. It is similar to one cabinet that has multiple cubby holes. A lawsuit against one series does not affect the others. Real estate investors often use them so that each series owns a separate property. A lawsuit on one of properties, for example, does not expose the others.
It is formed just like a regular LLC, except that its articles of formation must specifically state that it is authorized to form series. The initial LLC is sometimes referred to as master LLC, base LLC, umbrella LLC, or parent LLC. The series it creates can also go by different names. They have been referred to in the industry as cells, containers, divisions, subsidiaries, or units. Once the initial master LLC is created, it can create additional series as the need arises.
Initially established in Delaware in 1996, the Series LLC (SLLC) is, as-yet, a little-known asset protection instrument. Only a handful of states outside of Delaware permit the legal establishment of SLLCs within their jurisdictions. These are: Alabama, Illinois, Iowa, Kansas, Missouri, Montana, Nevada, Oklahoma, Tennessee, Texas, Utah, and the District of Washington. California has a singular stance towards SLLC. It does not have a provision for the establishment of series LLCs.
However, it allows SLLCs formed in another state to operate as such in California, provided they register in the state as a foreign entity. Although a series LLC is similar to establishing multiple companies, it offers a structure that is often less costly to set up and easier to manage. As with any asset protection tool, an SLLC has advantages and disadvantages. It is always best to explore the different options for your particular business situation before making a final decision.
The master LLC generates an operating agreement that establishes the ground operational rules for the series. However, this operating agreement allows for each series to create customized rules for its own specific operations. The master LLC is required to file articles of formation just once. Each additional series thereafter will be created through internal mechanisms stipulated in the operating agreement, or separate public filings, depending on the jurisdiction.
Each series operates as a distinct entity with its own name, bank accounts, and accounting books and records. They may have different members and managers, whose rights and obligations typically vary from series to series. Each series can conduct its own business including entering into contracts and holding titles to properties. Assets owned by each series is distinct and separate from assets owned by other series under the same master LLC. Because of this, each series is protected from liabilities that may be incurred by another series. A series LLC provides excellent asset liability protection without a lower cost than setting up a separate LLC for each asset.
Series LLC vs. Holding Company
Before the creation of series LLCs, businesses often used holding companies to separate assets and limit liabilities. This requires the formation of several LLCs. Each LLC owned a distinct set or grouping of assets, distinct from the assets held in another LLC. Each LLC would also be solely responsible for any liability they may incur. These individual LLCs would then be placed under a holding company. A holding company does not actively engage in business. As its name suggests, it merely holds something—like land, houses, or vehicles. In this case, it holds the group of LLCs that each in turn houses a specific asset. Every time a business owner wants to place an asset under the holding company, a different LLC must be created.
A series LLC is a more efficient structure. It requires the setting up of only one master LLC instead of several LLCs. In some of the states that recognize series LLCs, only the master LLC is required to file a certification of formation and annual reports. In some cases, such as in Texas, only the master LLC is required to file tax returns.
Furthermore, unlike a holding company, the master LLC can conduct its own business and generate an income. It can even help direct the growth of each series under its umbrella within the terms of its operating agreement.
Advantages of a Series LLC?
As seen above, a clear advantage of a series LLC is its ability to shield the assets of each series from the liabilities of the other series, or even from the liabilities of the master LLC itself. There is a caveat regarding this advantage though. Series LLC managers must take care to keep each series separate and distinct from other series under the master LLC. Administration costs and duties may be shared among series, but not accounting records, bank accounts, or other similar documents. Doing so will likely make the liability wall between series easier to breach in a legal challenge.
Another advantage of an SLLC is its incredible flexibility. A series within the master LLC can have its own members, purpose, and security interests. It can own, acquire, or sell a wide variety of tangible and intangible assets, including patents and intellectual property. The assets in a series can be held in the name of one of the series or in the name of the master LLC. One can elect a nominee manager for privacy. Additionally, master LLC creators enjoy almost complete freedom of contract in formulating their operating agreements. Thus, the series LLC can, within legal bounds, be as individual and unique as its creators can imagine it to be.
In terms of taxes and formalities, such as maintaining corporate records, a series LLC has a less complex structure than a corporation with subsidiaries. Because of this, they are easier to run and manage. In some states, the rent that one series pays to another series within the same master LLC may be tax-exempt. And, as long as records such as accounting and bank accounts are maintained separately, series can be administered collectively, which can lead to additional savings.
Disadvantages of Series LLCs
Despite its advantages, one would wonder why series LLCs are recognized in only a handful of states. One major drawback of a series LLC lies in the untested legal implications of its inherent structure. Being a relative new instrument, it does not yet have a long litigation history. The strength of its liability protection features has not been expansively tested—and found consistently effective—within the American legal system. There have simply not been enough cases filed in court that yield answers (legal resolutions) to basic questions and concerns. For example, will a court in a non-series LLC state accept the liability separation between series under the same master LLC? There are simply not enough legal precedents to go on.
Additionally, states that do recognize the SLLC structure show varying levels of regulations governing the instrument. Some states, such as Illinois, require series LLC creators to adhere to a stringent set of rules. Other states, like Delaware, follow a less rigid formation process. Given the disparity, would a state with a more onerous series LLC set-up recognize the integrity of a series LLC formed in a state that does not subscribe to the similar set of regulations? At this point, the answer is not clear.
There is also uncertainty surrounding series LLCs in the tax arena. Tax advisors do not yet know how they will be treated from one state to another for tax purposes. Hence, many remain wary of recommending series LLCs to their clients. The IRS has also not yet issued any definitive regulations on SLLCs. Until it does, series LLCs will likely remain an instrument only the bold and fearless will utilize. No business or asset owner wants to be caught flat-footed by the IRS. Until the states and the IRS implement clear tax guidance regarding series LLCs, tax experts will continue to hold this instrument at arm’s length.
Series LLC creators may also encounter a certain amount of resistance from banks when opening accounts for different series under a master LLC. Few banks or their legal departments are familiar with the inner workings of series LLCs. Because of this, they may impose additional requirements or more stringent documentation from SLLC creators. Securing a loan for a series may also prove to be more cumbersome and tedious for the same reason.
Series LLCs are useful instruments. They provide asset protection, have a simple yet effective structure, and are extremely flexible. They give creators and members a wide range of options as far as setting up, growing, and protecting their interests. One series LLC can yield the same benefits as multiple LLCs under a holding company. Because LLCs are still relatively new instruments, however, they are still untested in the legal arena. This is one of its main drawbacks. Additionally, there is no clear tax guidance issued by the IRS or state governments regarding SLLCs to date. This makes tax advisers wary of recommending them to their clients. For the most part, series LLC remains uncharted territory in the asset protection world. The best advice therefore, would be to proceed with caution and to seek the guidance of an expert in the field.