Delaware Series LLCs & Tax Strategies
As a refresher, the concept of a Series LLC (Limited Liability Company) was created by the Delaware Legislature back in 1996. It’s still considered the “Grand Daddy” of a hybrid “parent-child” (or a brood of children) business structure in use today.
The structure boasts many benefits. Asset Protection may be the top priority among many participants and of special appeal to both rookie and professional real estate investors alike. Additional advantages include anonymity, simplicity, and flexibility among others.
As we previously described in our article, Series LLCs 101: A Primer, this legal innovation is a business model unique among sole proprietorships, partnerships, corporations, non-profits or any other LLCs. But it does share similarities to all other organizational structures.
Your Series LLC is Like a Honeycomb
Consider a beehive and honeycomb as an analogy. In a Series LLC (SLLC), one master entity (the honeycomb) includes as many or as few “cells” as the “members” of the colony decide to create. Each is independent, or each can be codependent. The extent of the relationship is determined solely by the bees (investors, members, “owners”).
Ignoring all the other potential advantages and benefits of an SLLC, the focus here is on minimizing or avoiding tax liabilities by legally exploiting local, state, and federal regulations. But before we start, a few ground rules:
- There are no residency requirements for members. While increasing legislation in 16 states, D.C. and Puerto Rico – with much more on the horizon – has adopted some version of the original Delaware Model in the past few years, there is no residency requirement for participation as Founders or Members. This is true whether the business, entity or individual is based in another state, territory, Canada, or Antarctica.
- Tax concerns are complex and ever-changing. There are innumerable municipal / local, over 3,000 county, 50+ state categories (fuel, sales, excise, “fees, assessments and levies” and hidden costs in the conduct of business and investment. The “smoke and mirrors” continue in dealing with the IRS, where the average effective or, “Actual Tax Rate” (ATR) is not 35% … ‘more like 22%.
- These are just the basics. The following overview is not, cannot be, anything but an outline of considerations. We always recommend discussing your individual circumstances and objectives with experienced experts who specialize in the field of SLLCs and tax planning.
But, understandably, most folks pay most attention to the impact that the IRS makes on net revenues and income. Since the feds are the biggest and most commonly shared threat to putting money into the bank, let’s focus on the 800-pound bear in the room.
Uncle Sam’s View of Series LLCs
Think of the Taxman like a bear who wants to raid our beehive. Maybe it’s a “chicken or the egg” paradox, but regardless the of money (“honey”), the bees and the entire beehive suffer when the IRS gets involved.
The good news is that Papa Bear/Uncle Sam has consistently issued letters, opinions, and directives that incorporate language in favorable to, in support of, protecting the legal rights of SLLC‘s and their participants. Even with those cases wherein the treatment of each series was not at issue, U.S. Tax Courts have classified each series as a separately-regulated investment company.
Although the case at hand involved a “trust” participating in a “series trust,” the message was clear in creating solid steel walls, rather than just wax, between each cell of the honeycomb. Whenever well-documented accounting procedures, a clear Operating Agreement, and sound business practices support the integrity of an SLLC, any and all tax benefits are due the participants.
While banks, insurance companies, statutory entities (or those owned by any government or political agency) cannot be registered as an SLLC, the IRS itself has stated that, “Generally, LLCs are not automatically included in this list, and are, therefore not required to be treated as corporations. (Any) LLC can file “Form # yadda-yadda-yadda” to elect their business classification.” Further provisions allow for changes of category, with 75 days notice.
Moreover, unlike most other business structures, multiple options are available to taxpaying members. Each can choose independent classifications as a non-profit, corporation, individual or as part of the “parent” LLC itself. “Check the Box” and “pass-through” returns are options available to all, as mandated by state and federal law. With the advance guidance and advice of experts during the planning stages, individual circumstance allows for individual strategies, regardless of fellow members’ decisions.
Constitutional provisions require other states to give, ‘full faith and credit” to taxpayers who reside elsewhere. If the legal entity is domiciled in, for example, Texas or Delaware, then Connecticut and Wyoming are obligated to honor the controlling tax laws of sister states. As the popularity of SLLC’s continues to grow exponentially, lawmakers and taxing agencies have been hard-pressed to maintain the pace. At the same time, such states as New York (through its Department of Taxation and Finance) has already issued the opinion that, “… for the purposes of personal income tax, all of the series will be treated as ‘partnerships’, which the authors interpret to mean that each series is to be treated as a separate LLC.”
We’d be lying if any claim were made that there is a universally-applicable “silver bullet” or magical solution to the tax ramifications of any investment or enterprise. One size does not fit all. But no matter what your federal tax bracket, your local and state tithes, may be … whether building your 1st home or investing in a casino on the Las Vegas Strip … even if you’ve owned a “Mom & Pop” family business for 3 generations … SLLC’s are worth exploring.
Do the homework. Consult experienced experts who specialize in SLLC law and tax planning. Protect the honey.