IRS Guidance on Series Limited Liability Companies
by Kim Szarzynski and Troy Christensen
Series limited liability companies (LLCs) have been around since the state of Delaware created them by statute in 1996. Although various states (including Texas as of the last legislative session) have followed Delaware in providing for series LLCs, other than a Private Letter Ruling issued by the Internal Revenue Service in 2008, the IRS has never issued any formal guidance on the federal tax treatment of series LLCs. However, that changed on September 13, 2010, when the IRS issued Proposed Regulation Section 301.7701-1(a) (Proposed Regulations) addressing the treatment of these entities for federal income tax purposes.
Following is a brief description of series LLCs generally and selected highlights from the Proposed Regulations.
What is a Series LLC?
A series LLC is a form of entity that allows a single LLC to establish one or more series of members, managers, membership interests, or assets, each of which has separate rights, powers, or duties related to specified property or obligations of the LLC. For example, LLC X, with members A and B, could form series LLC X-1 in which A and B share profits 60/40 from activity 1 and form series LLC X-2 in which A and B share profits 30/70 from activity 2.
A series LLC is expected to provide limited liability protection to the members of each series and eliminate the expense of forming multiple entities for members that want to segregate assets and liabilities of different activities. (In the example above, series X-1 and X-2 would not be liable for each other’s debts.)
What Guidance is Provided in the Proposed Regulations?
Entities to Which the Proposed Regulations Apply: The Proposed Regulations apply to series LLCs, partnerships and trusts, protected and segregated cell companies, and segregated portfolio and account companies, that are established under a state statute providing for such entities. In addition, the Proposed Regulations apply to foreign (i.e., non-U.S.) series entities conducting insurance businesses.
Separate Entity Status: Under the Proposed Regulations, each series of a series LLC will be treated as a separate entity for federal income tax purposes. As a result, each series will be classified under the “check-the-box” regulations and may make any federal tax election it is otherwise eligible to make independently of any other series. For example, if LLC X has series LLC X-1 with a single owner and series LLC X-2 with two owners, LLC X-1 will be a disregarded entity and LLC X-2 will be a partnership, barring any affirmative elections.
Segregated Liability for Taxes (Hopefully): Because each series is treated as a separate entity, each series should only be liable for federal income taxes related to that series. However, the IRS reserves the right to impose liability for taxes upon another series within an LLC to the extent the debts of one series can be paid by another series under other provisions of local or federal law.
No Employment Tax Guidance: At this time, the IRS has not issued guidance on the federal employment tax treatment of series LLCs. As a result, it is possible that each series within a series LLC will be treated as a separate entity for federal income tax purposes, while the series LLC itself, as the only “employer” for state law purposes, will be treated as the only “employer” for federal employment tax purposes.
Transition Rule: A taxpayer that has been treating all series within a series LLC as one entity for federal income tax purposes may continue to do so under the Proposed Regulations if certain requirements are satisfied. Generally, this transition rule will apply provided that: (a) the series was established and conducting business prior to September 14, 2010; (b) the series had a reasonable basis for the classification; and (c) neither the series nor any owner of the series or the LLC was notified as of September 14, 2010 that the classification of the series was under examination. Note, however, this transition rule will no longer apply if 50 percent or more of the ownership of such series LLC changes after September 14, 2010.
Annual Statement: The Proposed Regulations require an annual statement to be filed by a series LLC and each of its series to provide the IRS with certain identifying information to ensure the proper assessment and collection of federal income tax. The timing of and information required by this annual statement are still to be determined by the IRS.
Kim Szarzynski and Troy Christensen are both associates in the Business Planning and Tax practice group at Haynes and Boone, LLP. Kim can be reached at firstname.lastname@example.org, and Troy can be reached at email@example.com.