Series LLC tax issues.

• Author: Gerson, Craig
• Position: Limited liability companies

Since 1996, Delaware law has permitted a limited liability company (LLC) to register separate series within an LLC (collectively, a "series LLC"), thereby allowing LLCs to establish separate series of management and economic rights for specific assets or obligations; sec Del. Code Ann., tit. 6, [section] 18-215. Series LLCs permit each series to shield its assets from liabilities incurred in or against any other series in the LLC.Thus, an LLC that operates two businesses might create a "liability partition," by placing each business into a separate series, so that the liabilities of one do not jeopardize the assets of the other. Among other potential planning opportunities, series LLCs could (1) separate large corporate enterprises without triggering the consolidated return regulations, (2) potentially reduce state taxes, (3) avoid triggering the disguised sale rules or (4) possibly defer recognition of gain on sales of assets or entire businesses.

Uncertain Tax Treatment

Despite these potential opportunities, series LLCs may raise tax issues. From a Federal income tax perspective, the question is whether a series LLC should be treated as an umbrella LLC with subsidiary disregarded entities, or as multiple unrelated LLCs. If the interests of a series are treated as owned directly by the LLC members for Federal income tax purposes, then adverse tax consequences could result from using series LLCs.

For instance, a cornerstone of subchapter K is that a contribution of assets is generally not taxable, unless the contributing partner is relieved of liabilities in excess of the contributed property's basis or the partnership is an "investment company" under Sec. 721(b). However, treating a series LLC as individual tax partnerships may trigger gain on formation.

Example: Individuals J and K integrate their businesses by contributing the business assets to separate series of a Delaware LLC treated for Federal tax purposes as separate partnerships. Under Rev. Rul. 99-5, J and K are likely deemed to have sold half of their interests in the contributed business assets to each other before forming the partnerships. The deemed swap results in J and K recognizing half of the gain on the assets of both businesses.

Changes to a Series LLC

Similar problems may confront a Delaware LLC considering whether to add or eliminate a series. Either procedure is simple under Delaware law. To add an LLC series, the LLC need only amend its LLC agreement and file a...