Disadvantages of Using a Series LLC

Although the Series LLC has become increasingly popular, there is a certain degree of uncertainty surrounding the Series LLC form.

Legal Separation of the Assets and Liabilities under State Law

The legal separation of the assets and liabilities of each series in a Series LLC has not been evaluated in court. Although the state Series statutes generally all provide for legal separation of series, it is unclear whether courts in other states and/or jurisdictions would recognize a legal separation of assets and liabilities within what is theoretically a single entity.  Therefore, even if a Iowa Series LLC, for example, were properly operated and each Series of the entity was kept separate with distinct records relating to the assets and liabilities of each series, a court in another jurisdiction could determine not to recognize the legal separation afforded under Iowa law for example. In other words, outside of the states that have specific Series LLC law, it’s not guaranteed that the inter-series liability protection will be respected. In addition, it is unclear how the states with non Series laws will treat Series LLC from an entity prospective for state administrative purpose. For example, although the State of California has not officially recognized the Series LLC from a legal perspective, the California Franchise Tax Board has recognized them from a tax perspective, and has said it will tax each Series individually.

One should generally be concerned about how Series LLCs will be treated by the states that don't have laws permitting them. If, for example, you set up a series LLC in Delaware then register it as a foreign entity conducting business in the state of New Jersey, each series in the LLC own a separate piece of property. If there's a lawsuit in regards to one of these properties you can't be sure that the New Jersey court will honor the series structure of the LLC, applying Delaware's law to the real estate and activities that are located in New Jersey. If they do, the claimant can collect only against the property in that series. If they don't, the claimant can collect against the properties in other series as well. States are expected to give full faith and credit to legislation of other states, but the answer is still somewhat uncertain.

U.S. Federal Income Tax Treatment

Although the formation of Series LLC is currently permissible under the laws of Delaware, Illinois, Nevada, Iowa, Oklahoma, Tennessee, Texas, and Utah, there is a general likelihood that other jurisdiction may not recognize different Series of a LLC as separate and distinct entities. In those jurisdictions that have not adopted legislation allowing for the formation of the Series LLC, there exists uncertainty in the actual level of asset protection offered, as well as the amount of potential tax savings. Moreover, the Internal Revenue Service has not issued a ruling relating specifically to Delaware Series Limited Liability Companies (this entity structure of liability segregation was first approved in Delaware). The Series LLC's line of business and profit and loss sharing arrangements must be examined carefully in each case to determine if the Series within the Series LLC consist of separate businesses, for which separate returns must be filed

In general, the series LLC is not more widely used largely because its tax treatment has not been fully resolved and because its effectiveness has not been tested judicially. Currently, the federal tax treatment of Series LLCs with multiple members remains unclear.

However, on January 18, 2008, the Internal Revenue Service issued Private Letter Ruling 200803004, which ruled that the Federal tax classification (i.e., disregarded entity or partnership or taxable association) is determined for each series independently. Thus, for example, if there is only one owner of series 1, then series 1 can be a disregarded entity (assuming it does not elect to be taxed as an association). And if series 2 has two owners, then it will be treated as a partnership. In addition, it is believed that a series with different members (or the same members but having different interests) is likely to be treated as a different partnership under Federal tax law.

Although Private Letter Ruling 200803004 offered some guidance as to the federal tax treatment of Series LLCs, many states have not provided concrete guidance on the effect of the series distinction for state tax purposes. While states typically follow the federal rules in classifying business entities for state tax purposes, certain states have addressed the classification of series limited liability companies in the absence of formal guidance at the federal level. The California Franchise Tax Board has asserted that each series of a series limited liability company will be treated as a separate entity for California filing and tax purposes. The California Franchise Tax Board's position is premised on series possessing the following characteristics: (i) the holders of the interests in each series are limited to the assets of that series upon redemption, liquidation, or termination, and may share only in the income of that series; and (ii) under state law, the payment of expenses, charges, and liabilities is limited to the assets of that series.

In addition, in Illinois a "limited liability company and any of its series may elect to consolidate their operations as a single taxpayer to the extent permitted under applicable law." This provision appears to presume that each series and the limited liability company is, by default, a separate entity for tax purposes unless an election is made to consolidate operations for tax purposes.