The Series LLC Conundrum
By Kevin Vela
Series LLCs have proven to be a fantastic tool for Texas real estate investors, and for other business owners and investors. Countless persons have taken advantage of the ability to pay only a single filing fee with the Texas Secretary of State, but yet separate the liability of different properties or businesses by complying with the applicable provisions of Section M of the Texas Business Organizations Code Chapter 101.
Unfortunately, a disconnect between the Texas legislature and the Texas comptroller have limited how Series LLCs can be used.
The problem lies in the ability (or inability) to designate different members for the “cells” within the Series. (Think of the filed LLC as the “parent” and each series underneath it as a child or “cell” to the same parent). Currently, in order to maintain proper franchise tax reporting abilities, the members of each cell need to be identical.
The problem is that the language of the TBOC, which breathed life into Series LLCs, infers that cells may have different members than the other cells or even the parent. Section 101.601 of the TBOC states that:
A company agreement may establish or provide for the establishment of one or more designated series of members, managers, membership interests, or assets that: (1) has separate rights, powers, or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations;…(I added the underlines for emphases.)
If you take just the underlined text, the TBOC allows for the “establishment of one or more designated series of members or membership interests that has separates rights, powers, or duties with respect to profits and losses associated with specified property.”
This makes sense and could save countless investors from filing a separate Certificate of Formation with the State of Texas for different, but related businesses (for example – real estate investment properties) where a single group of owners have different interest levels in different properties (or cells).
The problem is that the Texas Comptroller has taken the stance that cells within a series shall be combined into a single franchise tax report and filed as a single entity (if you’re really bored you can read the Comptroller’s tax policy division official letter here). As a result, I haven’t yet found an accountant who can file a single entity franchise tax report for a Series LLC with different membership structures within each cell.
Further complicating the mess is that the IRS seems to allow cells within a series to file individually.
In September 2010, the Treasury Department issued proposed regulations explaining how a series would be treated for federal income tax purposes. The proposed regulations generally treat each series of an LLC as a separate entity and apply the check-the-box entity classification provisions to each. (Though it is important to point out that the proposed regulations do not address the entity status of the parent organization itself; rather, they only address the status of each series underneath the series organization.)
The Texas legislature addressed the issue last year when it amended Section 101 Subchapter M of the TBOC and added the following:
Sec. 101.622. SERIES NOT A SEPARATE DOMESTIC ENTITY OR ORGANIZATION. For purposes of this chapter and Title 1, a series has the rights, powers, and duties provided by this subchapter to the series but is not a separate domestic entity or organization.
The fact that the code now specifically states that each cell is not a separate domestic entity or organization really seems to solidify the notion that, despite the Series LLC creation language in the TBOC, the members need to be the same from cell to cell; at least for now.