The Series Limited Liability Company - dummies

By Jennifer Reuting

In certain states, a limited liability company can be comprised of numerous series (or cells), each with its own separate veil of liability protection. This is called a series LLC, and it’s often used as an asset protection device that, in some states, saves the formation fees and the hassle of creating multiple LLCs for each asset.

Think of a cell as a protective barrier — whatever is contained inside it (usually a valuable asset of some sort) has its own veil of liability protection. Nothing can touch it. It’s as if each cell is its own LLC.

Series LLCs were created several years ago under Delaware state law for the purpose of simplifying structured financial transactions and collective investments such as mutual funds. Since that time, series LLCs migrated to other investments and business ventures, such as real estate. More states started offering them and/or recognizing them, and within a few years, they became the talk of the town.

Segregating your assets in a series LLC

Form a different entity for each of your assets (real estate, intellectual property, and so on) so that you can segregate each asset from the lawsuits and liabilities of the others. For example, if you own a taxi company, a common practice is to place each vehicle or two in its own limited liability company.

That way, if an accident occurs, the liability is confined to the one or two vehicles in that LLC, and the rest of the business and its assets remain secure. Same goes for real estate investments: If all your property is in only one LLC, then if a renter sues you and a judgment is awarded, all your properties are at risk of seizure. This isn’t the case if you segregate each property.

You see, you want each cell to be treated as a separate entity from the others — each one should have its own operating agreement and bank accounts, should prepare separate financial statements, and should file separate tax returns. Otherwise, you run the risk of the liability protection failing between one cell and another.

So if you want each cell to be treated as a completely separate LLC, then why not just form completely separate LLCs? What’s the benefit of a series LLC, anyway? Well, the answer is . . . not much. In some states, in which series LLCs are recognized, you can get away with paying only one filing fee (for the umbrella LLC) instead of the many fees you would have to pay if you went the traditional route of forming multiple LLCs.

But this is a benefit only if your LLC exists in one of these few states and doesn’t transact business in one of the many states with less favorable laws.

Only in rare situations do the benefits of series LLCs outweigh the risks. After all, the series LLC is a new type of business structure, and most states don’t quite know what to do with it. Series LLCs lack legal precedent (which means that their effectiveness hasn’t been tested in a court of law), and although the states that allow for their formation provide for that special barrier of liability protection between the different cells in their statutes, you have no guarantee that other states will agree.

And if you form your series LLC in Delaware and register it to transact business in California for the purpose of holding California real estate, then your court case will probably be subject to California law — which, in this case, isn’t a good thing!

Some states might recognize series LLCs, but this doesn’t mean that they need to recognize the liability protection between the cells. Having a series LLC in a state that doesn’t have specific laws clearly stating that each cell is treated separately is a pretty big risk.

So, is saving a few hundred bucks really worth it? Without the liability protection of a series LLC being tried and verified by a court of law, you are signing yourself up to be the test dummy if you are ever dragged into court. The irony is that, in the end, using an entity that’s meant to save you fees may be the very thing that ends up costing you everything!

Forming a series LLC

If you’re really set on going with a series LLC, it’s much easier to form than you may realize. The process is very similar to forming a regular LLC. In most states, you simply file the same articles of organization as you would for a regular LLC and add a provision that allows for the formation of series or cells within the company.

From there, the series LLC essentially exists in your company operating agreement. As you can imagine, series LLCs require much different operating agreements than standard LLCs, and because the rules governing your LLC can vary from cell to cell, the length of your operating agreement will probably closely correspond to the number of cells you have in your LLC.

Currently, you can form a series LLC in the following states:

Delaware Nevada Utah
Illinois Oklahoma
Iowa Tennessee
Kansas Texas

Additionally, Minnesota, North Dakota, and Wisconsin allow for the creation of series LLCs but don’t offer a liability shield among cells.

Maintaining a series LLC

Series LLCs aren’t bad for the businesses they were intended for — structured investments — but relying on liability protection holding up among the cells is of concern, especially for high-liability ventures such as real estate.

But if you’re absolutely intent on using a series LLC for your assets or operating business and are willing to take the risk, this section shows you how to maintain it in order to maximize your chances in court.

The first thing you need to understand is that series LLCs exist primarily in the operating agreement, and, given the flexible nature of the LLC, you have tremendous leeway as to how you structure each cell/series. If you want to add or remove cells, you simply amend your operating agreement. Your original filing (your articles of organization) remains unchanged.

If your series LLC ever ends up being scrutinized by a court of law, what you have written in your operating agreement is all that will uphold the insular nature of the liability protection among the various cells. Therefore, however you choose to structure your operating agreement, make sure that it’s rock solid.

When you’ve established that your operating agreement is as comprehensive and cohesive as it possibly can be, you need to simply be a series LLC. If the cells of your series LLC are intended to replace separate LLCs, then you need to act in accordance with that plan.

For all intents and purposes, each cell should be treated as a separate entity, complete with a separate set of books, records, and financials; a separate bank account; individual contracts; and so on. This includes having an additional, separate operating agreement for each cell.

Most, if not all, states allow you to elect whether your entire LLC is treated as a single taxpayer or each cell is treated as a separate taxpayer.

The IRS has ruled that each cell in a series LLC is treated as a separate entity for tax purposes. Each cell can have a separate tax ID number, elect a different form of taxation, and file a separate tax return. If the series LLC cell has elected partnership taxation, you should also file separate Form 1065s and issue separate Schedule K-1s to that cell’s members at the end of each fiscal year. Doing so helps to further establish the segregation of the cells in your series LLC.