LLC Tax And Banking Issues: A Brief Overview

Introduction

This article is intended as a brief and general overview of the basics of the subject and not intended to be specific tax advice for any individual or situation. Our law firm does not give tax, book keeping, or accounting advice. For that, we suggest consulting a CPA. In fact, one should consult a CPA each time you seek legal advice that may have tax consequences.

Obtaining an EIN

The quickest way to secure an EIN is from the IRS website (www.irs.gov). Alternatively, one may complete the IRS hard-copy SS-4 form and mail or fax it to Internal Revenue Service, Attn: EIN Operations, Cincinnati, OH 45999 (fax number 859-669-5760). An EIN may be obtained by calling (800) 829-4933 between 7:00 a.m. and 10:00 p.m. Monday through Friday. Note that the EIN application requests that the applicant list a responsible party along with that party’s social security number. The reason that many lawyers decline to obtain an EIN for a client is that they (understandably) do not want to list themselves as the responsible party.

The EIN process with respect to series LLCs is not complicated. Each series of a Texas series LLC is permitted (but not required) to have its own EIN, assumed name, and bank account. Some Texas banks (local or regional ones, for the most part) remain unfamiliar with series entities and an investor may have to explain to the bank officer applicable law found in the Business Organizations Code.

Federal Tax Returns

An LLC is required to file its own annual federal income tax return unless the company (and its series, if the LLC is a series company) is treated for federal income tax purposes as a disregarded entity—meaning an entity that is separate from its owner for federal income tax purposes. Under the IRS default rules for entity classification, IRS Regulations Section 301.7701-3(b), a single-member LLC is automatically disregarded and a multi-member LLC is automatically taxed as a partnership.

In a case where a natural person (form 1040 filer) is the only LLC member, the activities of the disregarded entity are reported on the taxpayer’s Form 1040—Schedule C. In a community property state like Texas, a husband and wife who wholly own an LLC as community property have the option of either receiving disregarded or partnership treatment (IRS Rev. Proc. 2002-69).

Alternatively, your CPA may assist you in filing the entity classification election to receive tax treatment other than that provided by the default rules (accomplished by means of Form 8832). The other option for a single-member LLC is being classified as an association taxable as a C corporation (in which case the entity would file Form 1120—a U.S. Corporation Income Tax Return); or an S corporation (in which case the entity would file Form 1120S—a U.S. Corporation Income Tax Return for an S Corporation).

A multimember LLC may also elect C or S status. Unless there is a compelling business reason to do so, C status should probably not be elected for most real estate investors. In general, according to IRS regulations, once an entity has made its tax election, an election may not be changed for 60 months.

So should your entity make an S Corporation election rather than stick with the default position of a disregarded entity? It depends. If the IRS considers the client as a dealer (doing this business for their livelihood) then their business income is subject to self-employment tax. The S Corporation election can be used to minimize that. If classified as a dealer, none of the gains are considered capital gains. All of it is considered ordinary income, subject to the tax rate the individual is in, plus self-employment tax.

IRS Returns for Series LLCs

Should an individual series file its own tax return? Not usually, not 90% of the time, but it may. If a series has its own EIN, activities that are different from other series, and/or a different membership structure, a separate annual federal income tax return may be best. Consult your CPA and let him know that the U.S. Treasury Department has proposed regulations (26 C.F.R. pt. 301) which would treat individual series as separate entities—each of which may elect pass-through tax treatment if the established criteria are met. The Journal of Accountancy states that “the tax treatment of the series will then be governed by the check-the-box regulations (Treas. Reg. Sec. 301.7701-1 through 301.7701-3). . . .

The IRS has apparently decided that factors supporting separate entity status for series outweigh factors in favor of disregarding series as entities. Among other things, this means that individual series may have their own K-1 (www.journalofaccountancy.com/Web/20103328.html).

All of the factors in this chapter are evolving and subject to rapid change. The IRS offers a helpful online tax workshop for new businesses designed to help small business owners learn their tax rights and responsibilities; but when it comes to determining tax treatment for individual series, there is no substitute for consulting a CPA knowledgeable in this area.

Texas Franchise Tax Returns

The Comptroller of Public Accounts sends a notice to new LLCs of the date on which their first state franchise tax report will be due (May 15th of the calendar year following formation). Filing franchise tax returns is usually the task of CPAs rather than attorneys, since CPAs are typically set up to easily file these electronically.

Prior to 2024, a Texas Franchise tax return was required to be filed even if the company had no income (the No Tax Due Information Report). This has changed. There is now a total-revenue threshold below which a franchise tax report need not be filed. If a taxable entity has annualized total revenue less than or equal to $2.47 million, it is no longer required to file a No Tax Due Report.

In summary, a taxable entity with annualized total revenue at or below the no tax due threshold:

(1) does not owe any tax;
(2) is not required to file a No Tax Due Report as was the case in past years;
(3) but is still required to file a PIR or Ownership Information Report.

A combined group of entities (as that term is defined by the comptroller) must include all taxable entities in the tax report for the combined group even if any member, on a separate entity basis, has annualized total revenue at or below the no tax due threshold. If a combined group’s annualized total revenue is at or below the no tax due threshold, the combined group is no longer required to file a No Tax Due Report, an Affiliate Schedule, or a Common Owner Information Report for that report year. However, each individual member of the combined group that is organized in Texas or has nexus in Texas must file a PIR or Ownership Information Report.

It may be useful to visit the Texas Comptroller’s website at https://comptroller.texas.gov/taxes/franchise/ in order to become acquainted with information and resources they offer.

Comptroller’s Public Information Report (PIR)

The annual filing of a Public Information Report (PIR, form 05-102) is required by the Comptroller. It is due by May 15th of the year following formation.

The PIR is a reasonably simple form. It requires disclosure of the names of each current “officer, director, or member” of the LLC. (Note that this is different from the Certificate of Formation which called for the names of the initial managers, not members.)

Since LLCs do not have directors, that is not an issue; however, one needs to supply the name of any person or entity who is a member, a managing member, or a non-member manager. This of course has implications for any anonymity strategy an investor may have.

Note that the PIR is differs from the Certificate of Formation, which required disclosure of only the names of the initial managers. The PIR wants to know the identity of the owners (members) as well.

Disclosures made in the PIR have implications for any anonymity strategy one may have, so care is required when filling out the PIR if anonymity is part of your asset protection plan.

There is no annual filing required at the Secretary of State’s office.

Failure to Pay Texas Franchise Tax

Failure to pay Texas taxes will result in forfeiture of the company’s right to transact business, including the right to sue and defend itself in Texas courts. If the company’s right to transact business is lost, then the company’s officers, directors, partners, members or owners may become personally liable for debts of the entity, including taxes, penalties and interest, which are incurred after the due date of the report and/or payment (Tax Code Sec. 171.251, 171.2515, 171.252, 171.256). To determine if the company is in good standing with the Texas Comptroller, call (800) 252-1281 or go to www.ecpa.cpa.state.tx.us. An LLC that is not in good standing cannot buy or sell real estate.

Not paying franchise taxes also has liability consequences for officers, shareholders, and members. Section 171.255(a) of the Texas Tax Code provides that such persons are not personally liable for the debt of an entity that has been forfeited because of non-payment of franchise taxes, but only so long as the debt was incurred prior to the forfeiture. If the debt was incurred afterwards, that is another matter.

Banking with a Series LLC

Banks have differing policies levels of familiarity with respect to series LLCs. These entities were adopted in Texas in 2009 and have been around in other states long before that, so there is really no excuse for a business banker at any major bank not to have knowledge of them—and yet lawyers hear about this occasionally. Local and regional banks present more difficulties than major banks.

There is no difference, operationally or legally, between a bank account that is opened for a traditional LLC and a bank account that is opened in the name of a series LLC for the company at large. Even so, an investor may have to point the bank officer to Section 101.601(20)(b) of the Texas Business Organizations Code: “A series established in accordance with Subsection (a) may carry on any business, purpose, or activity, whether or not for profit, that is not prohibited by Sec. 2.003.” Having said that, whether a bank will open an account for an individual series of an investor’s company is not a matter of legality. It is definitely allowed by law.

Banks—for their own individual (and occasionally inscrutable) underwriting reasons—choose what kind of accounts to open, what loans to make, and so forth. These are private business decisions on the part of the bank. No bank is obligated to open any sort of account if it does not want to. Your remedy is to choose another bank.

Legal Versus Tax Considerations in Asset Protection

One should distinguish between asset protection (generally) and asset protection structures (specifically) that are approached from a legal perspective versus a tax perspective. These can be different points of view.

An asset protection lawyer is primarily focused on courtroom outcomes—specifically avoiding large monetary judgments, since a large judgment can be an extinction event for a small business—unlike a slightly higher tax bill, which is a mere annoyance. Focusing on avoiding liability and lawsuits, and the protection of non-exempt assets in the event of a judgment . . . that is what an asset protection lawyer does. Tax considerations are secondary.

Approaching entity formation and deal structuring from a purely tax-driven perspective is a different avenue entirely, often employed by CPAs and attorneys who have no experience in a courtroom or with unpredictable outcomes from a judge or jury.

A narrow tax-driven approach may not always be entirely consistent with the best legal asset protection approach.

Occasionally, a real estate investor will have to decide where his or her emphasis is going to be: saving on taxes versus maximizing protections on the legal side. It may not always be feasible to maximize both sets of considerations. One can build a cruise liner or a battleship, but probably not both in the same vessel. Conservative investors tend to prefer the battleship, which is far more useful when pirates show up.