This brief article is very much a general overview of the basics of the subject and not intended to be specific tax advice for any individual or situation. This firm does not give tax, book keeping, or accounting advice. For that, consult your CPA. In fact, you should consult your CPA each time you seek legal advice that may have tax consequences.
There is a 2014 article on series LLC taxation I would recommend by Professor Alyson Outenreath, a tax expert and professor at St. Mary’s Law School, which goes into much greater detail that we do here. You may wish to Google it and read it or provide a copy to your CPA.
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 also 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) are new to series entities and an investor may have to explain to the bank officer what he or she is doing and direct him to 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.” A “disregarded entity” is disregarded as an entity that is separate from its owner for federal income tax purposes. Under the IRS default rules for entity classification, IRS Reg. § 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 to be classified as an association taxable as a “C” or an “S” Corporation. Unless there is a compelling business reason to elect “C” corporation status that is well researched, this status should 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. Dallas CPA Angie Sebeniecher advises as follows: “If the IRS considers the client as 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. It’s all considered ordinary income, subject to the tax rate the individual is in, plus self-employment tax. I usually recommend this for people flipping property on a regular basis.” Consult your CPA for advice relating to your specific circumstances.
Series IRS Returns
Should a series file its own tax return? Not usually, 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. Let your CPA know that the U.S. Treasury Department has proposed regulations, 26 C.F.R. pt. 301 (Sept. 14, 2010), which state that the IRS will 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. §§ 301.7701-1 through 301.7701-3). . . . The IRS decided that the factors supporting separate entity status for series outweigh the factors in favor of disregarding series as entities. . . . They specifically looked at the fact that the rights, duties, and powers of members associated with a series are direct and specifically identified. They also noted that individual series may have separate business purposes and investment objectives. The IRS concluded that these factors are sufficient to treat domestic series as entities formed under local law.” Among other things, this means that individual series will have their own K-1 (www.journalofaccountancy.com/Web/20103328.html).
The IRS offers a helpful online tax workshop for new businesses designed to help small business owners learn their tax rights and responsibilities.
Texas Margin Tax
As for Texas taxes, the Comptroller of Public Accounts sends a notice to new filers of the date on which the first state franchise tax report is due (May 15th). It will also show the LLC’s state taxpayer number (which is different from the file number at the Secretary of State’s office). The letter will also ask that you complete an online Tax Accountability Questionnaire within 30 days.
A Texas margin tax return must be filed with the Comptroller even if the company has no income. It is due by May 15th of the year following formation. Many new companies are eligible to file the No Tax Due Information Report (Form 05-163) if the LLC is a passive entity as defined in Tax Code section 171.0003; if it has annualized income less than the statutory threshold ($600,000); if the company has zero Texas gross receipts; or if the company is a real estate investment trust (“REIT”) as defined by Tax Code section 171.0001(c)(4). If your company does not fall into one of these categories, one will likely be filing the EZ Computation Report (Form 05-169).
The Franchise Tax Reduction Act of 2015 (Tax Code sec. 171.002 and sec. 171.1016) reduced the franchise tax rate for most businesses to .75% of the taxable margin. The rate for entities engaged in retail or wholesale businesses was reduced to .375%. All subject to change, of course.
For owners of more than one Texas registered entity, it will likely be necessary to include an Affiliate Schedule (Form 05-166). This is an unsettled area. The Comptroller is inclined to take the self-serving view that all real estate ventures with common ownership are “affiliated” for purposes of assessing the margin tax. Investors with multiple, varied interests know this is nonsense.
The Comptroller’s Public Information Report (PIR)
The annual filing of a Public Information Report (the “PIR” found on Form 05-102) is required by the Comptroller. It is due by May 15th of the year following formation. It is a simple form. The PIR requires disclosure of the names of each current “officer, director, or member” of the LLC. 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 nonmember manager. This of course has implications for any anonymity strategy an investor may have.
Visit the Comptroller’s website at www.window.state.tx.us. to view resources available. Their phone number is (800) 252-1381.
Failure to Pay the Texas Tax
Failure to pay Texas taxes will result in the company’s right to transact business, as well as the right to sue and defend itself in Texas courts, being forfeited. If the company’s right to transact business is lost, then the company’s officers, directors, partners, members or owners may become liable for debts of the entity, including taxes, penalties and interest, which are incurred after the due date of the report and/or payment—a highly undesirable result. See Tex. Tax Code §§ 171.251, 171.2515, 171.252, 171.256. For future reference, to determine if the company is in good standing with the Texas Comptroller, call (800) 252-1281.
There is no annual filing required at the Secretary of State’s office.
Banking with a Series LLC
Banks have differing policies and 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 the applicable law, which is contained in sec. 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, however—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.
Tax vs. Legal Considerations in Asset Protection
One should distinguish between asset protection (generally) and asset protection structures (specifically) that are approached from a legal versus a tax point of view.
An asset protection lawyer is primarily focused on likely courtroom outcomes—specifically avoiding adverse ones involving large monetary judgments, since a large judgment can be an extinction event for a small business—unlike a slightly higher tax bill. 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.
Approaching entity formation and deal structuring from a purely tax-driven perspective is a different avenue entirely, often employed by CPAs who may have no experience in a courtroom and lack knowledge concerning the vulnerability of assets. A narrow tax-driven approach may not always be entirely consistent with the legal approach.
In some cases, the legal and tax perspectives coincide. In others, an investor may have to decide where his or her emphasis is going to be: saving on taxes vs. 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. My money is on the battleship, which is far more useful in the event pirates show up.
This article has been intentionally brief. Even though basic tax information has been presented for general purposes, our firm does not give tax advice so this article is not a substitute for the ongoing advice and guidance from a good CPA who is a regular member of the investor’s team. All new LLC owners should consult a CPA concerning the best way to handle their new company for federal and state tax purposes. Certain tax benefits may be available but are not automatic.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well since we are not tax practicioners and do not offer tax advice. This firm does not represent you (i.e., no attorney-client relationship is established) unless and until it is retained and expressly agrees in writing to do so.
Copyright © 2018 by David J. Willis. All rights reserved worldwide. Reproduction or re-use of any this material for any purpose without prior written permission and full attribution is strictly prohibited. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.