THE SERIES LIMITED LIABILITY COMPANY
ILLINOIS AND DELAWARE
By: Richard M. Colombik JD, CPA &
Linda Godfrey, JD, CPA
Richard M. Colombik & Associates, P.C.
The Delaware legislature created a new form of legal entity by amending their Limited Liability Company Act in 1996.1 This new entity was named “The Delaware Series LLC.â€ Nine years later, Illinoisâ€™ version of the series LLC became effective on August 16, 2005.2
A â€œSeries LLCâ€ is a limited liability company that is permitted to own multiple subsidiary limited liability companies or a â€œseriesâ€™ of limited liability companies.. The Series LLC is required to be created in a state that allows classes or series LLCâ€™s, but it can register to do business or own property in any state. An existing Illinois or Delaware LLC may be converted into a series LLC.3
Illinois and Delaware both require an Operating Agreement to form a series LLC. This is true even if only one member owns each of the series in the LLC. Th operating agreement must create one or more series.4 The Delaware statute allows the series LLC members to add additional series within the LLC by amending the operating agreement. The Illinois LLC statute allows the creation of a series by filing a Certificate of Designation for each series.5
The LLC operating agreement may create several series LLCâ€™s for a variety of business objectives. In Illinois, each of the established series LLCâ€™s will function as a separate entity unless an election is filed to not so function separately. .6 In Delaware, the LLC and not the series will be treated as the legal entity.7
The operating agreement should establish the rights and obligations of the LLC members and managers. Classes or groups of members may be established in the LLC operating agreement whether it is an Illinois or Delaware entity. The classes or groups of members established within the operating agreements, will have whatever rights the operating agreement provides for. . The LLC operating agreement may also designate series of members, managers or LLC interests with separate rights and duties pertaining to specific LLC properties or obligations. Each series may also be allocated specific assets and have separate and distinct members and managers.8
Each series of an Illinois series LLC may own hold title to assets, grant security interests, contract, sue and be sued, and have different managers and members. The Delaware statute, however, is silent on whether the series LLC is able to hold title to assets, grant security interests, contract, sue and be sued. The Delaware Series LLC statutes state that the debts and liabilities incurred by one of the series LLCâ€™s will be enforceable only against the assets of any of that specific series. .9
Illinois and Delaware statutes do have specific similarities. These similarities are as follows:
- A series LLC can make distributions to its members without taking into account the financial condition of the other series.
- If the total series LLC is insolvent, distributions can be made from a solvent series LLC.10
- A series LLC can be terminated without affecting the other series LLCâ€™s.11
- Each series is a separate LLC within itself.
An event that causes a member to discontinue his association with a series LLC will not cause that member to terminate his association with any other of the series LLCâ€™s unless the operating agreement states a contrary conclusion. Disassociation will not terminate a member’s interest in the LLC or cause the termination of the series even if the member was the last surviving member associated with that specific series.12 Consent of the members, however, will terminate a series LLC at any time.
Illinois and Delaware also allow a foreign LLC that is properly registered to do business within their state if the LLC agreement establishes a designated series of members, managers or LLC interests and will also provide for limitation of liability on a series LLC assets for the debts, and obligations of a particular series. 13
A series LLC can be an important legal tool for asset protection. For example, many corporations own and operate more than one business and many individual real estate investors own multiple properties titled under a single name or business entity. Any legal liability relating to one business or property may potentially endanger other assets when a single owner has dominion, control and ownership of such assets. Generally, most owners of related businesses or real estate investors with several properties attempt to separate or segregate ownership so that lawsuits against one business or property will not endanger the other investments. This liability separation generally requires creating a separate and distinct entity to own each business or each property. Multiple entity ownership may become complex, paperwork intensive, as well as expensive when the businesses expand or prosper. A series LLC may help resolve these issues with the creation of one LLC and the creation and election of an underlying series of LLCâ€™s.
One of the major characteristics of the series LLC is the ability of each separate series to insulate property from liabilities incurred in or against any other series in the LLC. The existence of a separate series will protect the series LLC’s other assets and the other series LLCâ€™s assets from claims against a specific, given series. It will also protect the assets of various series LLCâ€™s from general claims against the series LLC. Both the Delaware and Illinois Statutes state that t
he assets of a specific series LLC14 are protected from enforcement action against the assets of the Series LLC or any other series LLC if the LLC operating agreement provides for all of the following:
- The operating agreement creates one or more series,
- Separate and distinct records are maintained for each series,
- The assets associated with each series are held (directly or indirectly, including through a nominee or otherwise) and accounted for separately from the other assets of the limited liability company or any of the other series,
- The operating agreement provides that the liabilities of each of the series will be separate and accounted for separately,
- Notice of the limitation on liabilities of a series is stated within the articles of organization of the limited liability company, and
- The limited liability company has filed a certificate of designation for each series which is to have limited liability under the appropriate Section.15
An important requirement of the Illinois and Delaware Series LLC statutes that must not be ignored is the requirement that each of the series keep separate records with distinct financial accounting information for each series. If the funds of different series are commingled, or if books and records are consolidated or not distinct , a creditor may have an argument that the Series LLC does not provide asset protection if the money of a separate series is commingled, or the records are consolidated or confused. A creditor may have a compelling argument that the Series LLC did not provide asset protection since it did not follow the statutory requirements. The series LLCâ€™s accountant (preferably their CPA) must be informed of and required to follow the appropriate statute, in this instance, Illinois or Delaware and be made aware of the specific and separate accounting requirements.16
The Illinois LLC Statute also provides that each series LLC may independently contract, hold title to assets, grant security interests, sue and be sued, and otherwise conduct business and exercise the powers of a limited liability company.17 This is a separate legal entity for ownership purposes. The Delaware LLC Statute only states the assets and liabilities are segregated for each series LLC.18 The Delaware LLC Statute is silent on the series LLC being a separate legal entity for ownership purposes.
Possible Uses of the Series LLC
A Series LLC may hold multiple parcels of real property and thereby obtain segregated liability for each parcel. . This is a more efficient and less expensive technique then creating, filing, and maintaining several different LLCs to segregate property ownership and provide liability insulation.. As noted above, the Illinois LLC statute allows each series LLC to hold title to its own assets.19
A business with multiple divisions, for example, may et up each division as a separate series LLC. . This could give the designated employees of each series LLC an equity interest tied to that series, if such a compensation structure and segregation was beneficial to the underlying owners. This may also allow a business to reward the employees at productive divisions and protect the same employees from the possible downsides of other divisions through segregated compensation structures and tiered ownership interests..20
An operating business that owns real estate used in their operation could benefit from a Series LLC. The business could form a Series LLC. One series LLC could own the real estate and a second series LLC could operate the actual business. Theoretically, the liability incurred by the business operations series would not endanger the real estate assets held within the series.21
A Series LLC may be also used to facilitate combining business operations. One example is instead of a traditional merger, the companies would form a Series LLC. The owners of each of the companies would contribute their ownership interests or assets to separate series LLCs. The LLC operating agreement would be drafted to state specifically which rights and responsibilities will be shared and which are to be maintained separately.22
Unfortunately as the series LLC is still a new business entity there is a dearth of case law and even less current tax law on point for guidance. It will be forthcoming as this type of structure becomes used more frequently and more productively by business and personal interests.
In order to determine how the series LLC will be treated for federal income tax purposes, we must look at the entity classification regulations contained within IRC Â§7701 and the treasury regulations therein.23 The treasury regulations provide an â€œeligible entityâ€ may elect their federal taxation classification.24 To determine what an â€œeligible entityâ€ is, one must examine the three part test.
The first test is that the series LLC must be an â€œentity.; The second test is that the â€œentityâ€ must be a â€œbusiness entityâ€. The third test is that the â€œbusiness entityâ€ must not be a â€œper seâ€ corporation. A series LLC is not generally deemed to be a â€œper seâ€ corporation.25
Lets examine these federal tax issues.
Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.26 While there is no specific definition of the term â€œentityâ€ in the Code or regulations, the courts and the IRS usually have treated an organization as an â€œentityâ€ if the organization changes the legal and economic relationship between the owners of the organization and their assets.27. When an LLC is treated as the owner of the series for federal tax purposes, the federal tax consequences are essentially the same whether the series is a separate entity or not. In either case all of the assets and liabilities of the series are treated as owned by the LLC.28 If an LLC series is considered owned directly by the LLC members, then whether that series is a separate entity should rest on the effect that creating the series had on the legal rights and obligations of the LLC owners. The creation of a series should generally alter the legal rights.29
The Delaware LLC statute states that the parent in a series LLC is a separate legal entity.30 But the statute is silent on whether each series is a separate legal entity.31 The Delaware statute does not provide a series LLC with the authority to contract, hold title to assets, grant security interests, and sue or be sued.32 These rights and obligations are important in determining whether the series LLC is a separate entity.33
The Illinois series LLC creates its own existence by filing a separate certificate of designation and can register to do business under its own name.34 The Illinois statute is very clear on whether the series LLC is a separate entity. The statute states, â€œA series with limited liability shall be treated as a separate entity to the extent set forth in the articles of organization.â€35 The statute further states that the series LLC â€œmay, in its own name, contract, hold title to assets, grant security interests, sue and be sued and otherwise conduct business and exercise the powers of a limited liability company under this Act.â€36
The next determination is whether the series LLC series is an independent â€œbusiness entity.â€ A â€œbusiness entityâ€ is defined as any recognized entity that is not classified as a trust or subject to special tax treatment for federal tax purposes.37 Morrissey v. Comr., 296 U.S. 344 (1935).38 and Commissioner. V. Culbertson 39 are the two significant cases that explain the application of the entity classification regulations. In Morrissey, id , the Supreme Court distinguished a trust from an association based on the purpose of the entity. The court stated the purpose of a trust is to hold and conserve property and the purpose of an association is to provide a vehicle for conducting business and sharing its gain. In Culbertson, id, , the court held that a partnership must be respected if the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. According to Morrisey and Culbertson, the entity will be considered a â€œbusiness entityâ€ if it meets the following two objectives: (1) be a profit making business, and (2) not simply protect or conserve property as in a trust.40
Neither the Delaware Series LLC statute nor the Illinois Series LLC statute requires the series LLCâ€™s to have a separate business purposes. Each series may have a separate business purpose.
The Illinois statute provides that the LLC and any of its series may elect to:
Consolidate their operations as a single taxpayer to the extent provided under applicable law,
Contract jointly, or
Be treated as a single business for purposes of qualification to do business in this or any other state.41
The default treatment of the series and parent LLC under the Illinois statute treats the series and parent LLC as separate entities unless the series and parent LLCs choose to be treated as one taxpaying entity.42 Therefore, individual series created under the statute are â€œbusiness entitiesâ€ separate from the parent LLC and should be treated as a â€œbusiness entityâ€ for federal tax purposes. The Delaware statute has no such provision. Delaware series LLC will have to meet the Morrisey43 and Culbertson44 objectives in order to be considered a â€œbusiness entityâ€ which are to be in a profit making business and not be only protecting or conserving property.
The Illinois statute lists additional powers granted to an LLC series that are associated with independent taxable entities. The Illinois series creates its own existence by filing a separate certificate of designation,45 whereas the Delaware series must amend the certificate associated with the parent LLC. The Illinois certificate of designation allows the series to register to do business under its own newly created name in Illinois or in any other state. The only requirement showing any connection to the parent company is that â€œthe name of the series with limited liability must contain the entire name of the LLC and be distinguishable from the names of the other series set forth in the articles of organization.â€46 The Illinois statute gives the series the capability to individually and separately contract, hold title to assets, grant security interest, sue and be sued, and otherwise conduct business, and exercise the powers of a LLC under the Illinois LLC Act.47
Once the series LLC is determined to be an â€œeligible entityâ€, they may elect their federal tax classification. An â€œeligible entityâ€ with two or more members may elect to be classified as either a partnership or a corporation. The â€œeligible entityâ€ with one member may elect to be classified as either a disregarded entity or a corporation.48
1 6 Del. Code Ann. 6 Â§18-215 (2006).
2 805 Ill. Comp. Stat. 180/37-40 (2005).
3 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
4 Wolf, A.J. The Illinois Series LLC. Robbins, Salomon and Patt, Ltd. Attorneys at Law. Newsletter (Spring 2006)
5 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
6 805 Ill. Comp. Stat. 180/37-40 (2005).
7 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
8 Adkisson, J. & Riser, C. Series LLCs for Fractional Ownership. When One is Better than Many: The Series LLC, (April 2005) <http://www.assetprotectionbook.xom/Dev_Apr2005.htm#series>.
9 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
10 6 Del. Code Ann. 6 Â§18-215 (2006).
14 Niemann, T.M. & Madison, M.S. The Series LLC: new Illinois law provides avenue for asset protection, Illinois Bar Association. Real Property. November 2005. Vol. 51, No. 2.
15 805 Ill. Comp. Stat. 180/37-40 (2005).
16 Riser, C. M. Series LLC, Offshore Today, September 22, 2000
17 805 Ill. Comp. Stat. 180/37-40 (2005).
18 Murray, J. C. The Delaware Series LLC >.
19 Adkisson, J. & Riser, C. Series LLCs for Fractional Ownership. When One is Better than Many: The Series LLC, (April 2005)
20 Riser, C. M. Series LLC, Offshore Today, September 22, 2000.
21 Wolf, A.J. The Illinois Series LLC. Robbins, Salomon and Patt, Ltd. Attorneys at Law. Newsletter (Spring 2006)
22 Adkisson, J. & Riser, C. Series LLCs for Fractional Ownership. When One is Better than Many: The Series LLC, (April 2005) .
23 Gerson, C. A. Taxing Series LLCs. Tax Management Memorandum March 8, 2004, Vol. 45 No. 05.
26 26 CFR Â§301.7701-1.
27 Gerson, C. A. Gerson, Esq. Taxing Series LLCs. Tax Management Memorandum March 8, 2004, Vol. 45 No. 05.
30 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
32 Gerson, C. A. Gerson, Esq. Taxing Series LLCs. Tax Management Memorandum March 8, 2004, Vol. 45 No. 05.
33 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
37 Gerson, C. A. Gerson, Esq. Taxing Series LLCs. Tax Management Memorandum March 8, 2004, Vol. 45 No. 05.
38 Morrissey v. Commissioner., 296 U.S. 344 (1935).
39 Commissioner. V. Culbertson, 337 U.S. 733 (1949).
40 26 CFR Â§301.7701-2.
41 805 Ill. Comp. Stat. 180/37-40 (2005).
42 Terry, C.T. & Samz, D. D. An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies. Tax Notes, March 6, 2006 at 1093-1098.
43 Morrissey v. Comr., 296 U.S. 344 (1935).
44 Comr. V. Culbertson, 337 U.S. 733 (1949).
45 805 Ill. Comp. Stat. 180/37-40 (2005).
48 26 CFR Â§301.7701-3.