DE Series LLC’s & Tax Strategies
As a refresher, the concept of a Series LLC (Limited Liability Company) was created by the Delaware Legislature as the “Grand Daddy” of a hybrid “parent-child” (or a brood of children) business structure back in 1996. Arguably, 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 LLC’s 101: A Primer”, this legal innovation is a business model unique among sole proprietorships, partnerships, corporations, non-profits or any other LLC’s … yet share similarities to all other organizational structures. Let’s stick with the beehive – honeycomb 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 co-dependent. 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:
1) 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, (Texas is essentially identical, but for any requirement of annual renewal fees) there is no residency requirement for participation as Founders or Members – whether the business, entity or individual is based in another state, territory, Canada or Antarctica.
2) Among taxing agencies: 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%.
3) The following overview is not, cannot be, anything but an outline of considerations to be discussed in depth with experienced experts who specialize in the field of SLLC’s and tax planning, related to individual circumstance and objectives.
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.
As any zoologist will confirm, bears don’t raid a beehive to get to the honey, they’re after the bees. Maybe it’s a, “the chicken or the egg” paradox, but regardless the money (uuuhhh, the honey), the bees and the entire beehive suffer when the IRS gets involved.
The good news is that Papa Bear 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. “The IRS has continued to follow that separate-entity treatment in analyzing … in several private letter rulings.”
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, LLC’s 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 (sic) 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 (or brother) 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.