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THE SERIES LIMITED LIABILITY
COMPANY
ILLINOIS AND
DELAWARE
By: Richard M. Colombik JD, CPA
&
Linda Godfrey, JD, CPA
Richard M. Colombik & Associates,
P.C.
www.colombik.com
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.” Nine years later, Illinois’ version of the series
LLC became effective on August 16, 2005.2
A “Series LLC” is a limited liability company that is permitted to own
multiple subsidiary limited liability companies or a “series’ of limited
liability companies.. The Series LLC is required to be created in a state that
allows classes or series LLC’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 LLC’s for a variety of business objectives. In Illinois, each of the
established series LLC’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 LLC’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:
1. 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
LLC’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 LLC’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
Asset Protection
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 LLC’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 LLC’s assets from claims
against a specific, given series. It will also protect the assets of various
series LLC’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 LLC’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.
Federal Taxation
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 §7701 and the treasury regulations therein.23 The
treasury regulations provide an “eligible entity” may elect their federal
taxation classification.24 To determine what an “eligible entity”
is, one must examine the three part test.
The first test is that the series LLC must be an “entity.; The second test is
that the “entity” must be a “business entity”. The third test is that the
“business entity” must not be a “per se” corporation. A series LLC is not
generally deemed to be a “per se” corporation.25
Lets examine these federal tax issues.
Entity
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 “entity” in the Code or
regulations, the courts and the IRS usually have treated an organization as an
“entity” 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, “A series with limited liability
shall be treated as a separate entity to the extent set forth in the
articles of organization.”35 The statute further states that the
series LLC “may, 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.”36
Business Entity
The next determination is whether the series LLC series is an independent
“business entity.” A “business entity” 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
“business entity” 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 LLC’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,
-
Work cooperatively,
-
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 “business
entities” separate from the parent LLC and should be treated as a “business
entity” 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
“business entity” 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 “the 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.”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 “eligible entity”, they may elect
their federal tax classification. An “eligible entity” with two or more
members may elect to be classified as either a partnership or a corporation.
The “eligible entity” with one member may elect to be classified as either a
disregarded entity or a corporation.48
________________________________________________________________________
1 6 Del. Code Ann. 6 §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 §18-215 (2006).
11 Id.
12 Id.
13 Id.
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.
24 Id.
25 Id.
26 26 CFR §301.7701-1.
27 Gerson, C. A. Gerson, Esq. Taxing Series LLCs. Tax
Management Memorandum March 8, 2004, Vol. 45 No. 05.
28 Id.
29 Id.
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.
31 Id.
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.
34 Id.
35 Id
36 Id.
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 §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).
46 Id.
47 Id.
48 26 CFR §301.7701-3.
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