FTB Rules Against Delaware Series LLCs PDF Print E-mail
I am often asked whether or not a Delaware Series LLC is a good business entity to transfer multiple properties into compared to having a single member limited liability company (“SMLLC”) own each property.  Usually the main reason this question is asked is because the position taken by advocates of the Delaware Series LLC that you are able to avoid the California gross receipt fee costs or the minimum annual franchise tax for each property and only have to pay one overall fee.  The minimum annual franchise fee tax is $800 for the franchise tax.

Having properties in separate limited liabilities companies (“LLC”) from an asset protection standpoint is a very easy decision.  The problem is when there are multiple properties and justifying the overall ongoing costs associated with having separate entities (franchise fees and accounting) compared to the likelihood of something actually happening (tenant injury covered by insurance) on one of the properties.  I personally have my properties in separate LLCs and feel the extra cost is cheap insurance if something does go wrong.

My reply to the question of whether or not the Delaware Series LLC is a good business entity is two fold.  First, the Delaware Series LLC is relative new and is unclear other than in Delaware how it actually works for creditor protection. Although there is only one overall document, each series LLC will have to be treated as a separate entity. Since it has been untested in the California courts, recommendations by advocates include (i) the filing separate fictitious business name (ii) establishing separate bank accounts (iii) avoiding commingling of assets and (iv) maintaining separate books and records.

My second response to whether or not the Delaware Series LLC is a good business entity to actually utilize was that the California Franchise Tax Board (“FTB”) would more than likely rule that each series LLC was actually a separate business entity and you would then have to pay all franchise fees tax owned.  The FTB announced in it March/April 2006 Tax News that it has ruled that a Delaware Series LLC will have to pay for each separate LLC the minimum annual fee.  I have provided below the FTB’s position.

What is FTB's position on Delaware Series LLCs?  The business community is requesting tax-filing guidance from state government on the Delaware Series Limited Liability Company (LLC). The Delaware Series LLC is a relatively new business entity classification and there is minimal federal guidance on whether each series within a master series LLC is a separate taxpayer. We have taken the position that each series within the Series LLC is a separate business entity and each has a filing requirement if it is registered or doing business in California. Members of our audit staff have identified many issues associated with Series LLC that could lead to abusive tax strategies if they are not appropriately addressed.

Under the Delaware LLC Act, Section 18-215, a single LLC agreement may establish one or more designated series of members, managers or LLC interests having separate rights, powers or duties relating to specified property or obligations of the LLC or profits and losses associated with specified property or obligations. Any such series may have a separate business purpose or investment objective. Additionally, a series may be terminated and its affairs wound up without causing the dissolution of the LLC. Other states have passed series LLC legislation.

A Series LLC is essentially a master LLC that has separate divisions, similar to an S corporation with Q-subs. Each division has its own liabilities and assets and a creditor should only be able to pursue that entity's assets rather than the entire series' assets. The claimed business purposes are liability protection and flexibility, with the added bonus that they would pay the LLC fee and the minimum tax only once.

The Treasury Department has not issued direct guidance on the tax treatment of Series LLCs. Review of the tax research services indicates that the Series LLCs are compared to the separate series of a single trust, which have been regarded as separate taxpayers as found in National Securities Series-Industrial Stock Series v. Commissioner, 13 TC 884 and Revenue Ruling 55-416. In addition, the IRS issued various private letter rulings based on those early authorities.

California has not adopted a statute similar to the Delaware Series LLC. Tax practitioners propose that only one form 568 needs to be filed for the entire series. FTB does not agree. Our current position is that each series in a Delaware Series LLC is considered a separate LLC and must file its own Form 568 Liability Company Return of Income and pay its own separate LLC annual tax and fee if it is registered or doing business in California. We included this statement with the 2005 Form 568 instructions and its updates.

Conclusion.  Given the FTB ruling, the Delaware Series LLC may not be the best selection for transferring multiple properties into as a mean to avoid the minimum franchise fee. 
 

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