Press Release January 25, 2013 - Delaware licenses 179 new series captives in 2012 - Read the full release by clicking here. While not mentioned, Captive Experts assisted with several dozen of these new SBU formations. As of 2013, at least 11 US states now authorize series/cell legal structures for captive and other use.
Expect increasing competition from Montana, Utah, Nevada and other states expanding captive legislation to compete more effectively with Delaware for the growing need and interest in small US domiciled captives, historically an exclsuive offshore industry. Eventually managers will figure out how to improve the structure documentation of these series/cell sepcial business unit captives so the banking limitations and legal concerns surrounding these hybrid legal vehicles become non-issues. For more information on how to avoid these concerns and limitations now, contact us.
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Why All the Excitement About Series LLCs for Captives? by Tom Cifelli, July 2011 (updated in November 2011)
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Great controversy surrounds the use of Series Limited Liability Companies and Protected Cell Corporation structures. Protected cell structure pioneered offshore. One main problem with the use of these novel legal entity structures is that should a lawsuit ensue in a jurisdiction outside where they are formed, whether or not they will be recognized as a separate entity from other series/cells or from the core is of concern. Also corporate governance issues arise. The US Treasury IRS division has agreed to recognize series and cells and separate tax entities, so the cost efficiencies have stimulated their creative use.
Having said all that, Tom Jones in his recent article touches clearly on why the use of a Incorporated Cell Structure is preferred despite the slightly higher costs of creation. We at Captive Experts agree. Click here to read the full article.
Read this decent article by two (2) Nevada lawyers on "The Uncertainties of Series LLCs," published in the December 2012 issue of Nevada Lawyer.
Background on Series LLCs
Series limited liability companies ("Series LLCs") in the US are modeled off of foreign protected cell corporation structures. Delaware introduced Series LLCs to the US. Each series is referred to as a Special Business Unit (SBU). Each SBU is treated as a pure captive for all practical purposes and SBUs can be created for 831(b) captives, group captives, and for larger captives. Once the "core" of a Series LLC is sponsored with the required $250,000 of minimum capital, new SBUs do not at this time have any minimum capital requirements, formation fees and costs are lower than a new stand alone captive, and approval by the regulatory staff is generally much faster. The main limitation of participating in an existing SBU is often you must select from an existing range of permitted lines of coverage. Each Series SBU can obtain its own tax number and file its own separate tax returns - they truly are for all legal purposes separate and protected legal entities despite being part of a larger entity. The quality of Series SBU documentation varies greatly as lawyers are just learning how to create and document this complex structures. Problems may arise in the future and litigation ensue due to drafting problems and absence of good corporate governance practices by each SBU.
The primary use today of Series SBUs other than by a captive applications is for multiple location investment real estate holdings and by the mutual fund industry. Series LLCs will be increasingly used in estate planning once the legal community better understands the flexibility and dynamics of this new advanced legal entity structure.
Series LLCs combine the attributes of separate corporations (such as a parent with subsidiaries) and partnerships into one legal entity, allowing each series/cell to function and account as a separate business and be protected from liability of other series SBUs. Reduced legal, tax and operating costs can be achieved. Depending on the state of domicile selected, the asset protection and tax characteristics may vary.
Please be aware that while the domicile enabling legal and insurance statutes bear on the authorization of the use of a Series LLC entity for a captive, the quality of documentation being used may vary dramatically between practitioners holding themselves out as experts in this rapidly evolving emerging legal structure area. Surely disputes will arise in the future among impacted parties either due to misunderstandings between them, or due to complications with the IRS, SEC or other regulatory agencies. We expect many series llc and protected cell structure programs to eventually discover important legal and corporate governance issues were not as well addressed as initially thought requiring significant improvements to many programs documentation and process controls. See Legal Variations for more on these looming issues.
General Discussion
Each "series" of a Series LLC (or "cell" of a protected cell entity) can own distinct assets, incur separate liabilities, have different managers and members, yet pay one filing fee and annual renewal fee, at this time.
Article Insert - Important Alert: Effective August 17, 2012, new Delaware SBUs (new series llcs) will be charged an application fee of between $1800 (under $1,400,000 annual premiums) to $3000 (over $1,400,000 annual premiums). SBUs are still not subject to minimum premium taxes as are stand alone pure captives and other captives. The parent core of a Series LLC is subject to the Delaware minimum $5,000 annual premium tax. The entire series is combined annually and taxed at 2/10ths of 1% on direct and 1/10th of 1% on indirect premiums. Therefore a new Series LLC SBU formed after 8-17-2102 expecting to keep premiums under $1.2 million annually to qualify for the 831(b) tax election will have to pay $1,800 for formation, and $1,200 annually in premium taxes to Delaware. See the August 17, 2012 bulletin of Delaware by clicking here.
Liabilities of one series/cell does not jeopardize assets of another cell (provided the entire structure is expertly crafted from inception). Adding and deleting a series/cell is easy. While the Series LLC is a fairly recent legal structure in the US, essentially similar protected cell corporations (PCC) have been used much longer. PCCs are single legal entities with cells managed in isolation from other cells with separate bank accounts, ledgers and agreements. Usually a preferred series of stock is issued for each new protected cell (as opposed to Incorporated Cell Structures where a new corporation is actually formed for each cell). PCCs used correctly avoid Controlled Foreign Corporation status where cell participation in overall profits are below 25%. A key benefit of this foreign PCC structure is tax on cell profits is potentially deferred until distributed as a dividend. Click here to watch Ross Elliott, Utah Captive Insurance Director, discuss cell captive benefits in this exclusive interview.
Leading US "Onshore" Domicile for Series LLCs
Delaware was the first state to enact supportive legislation in April 2005. Click here to watch exclusive video interviews with a senior Delaware official discussing Series LLCs.
Iowa, Oklahoma, Illinois, Tennessee, Utah, Wisconsin, Nevada, Texas and others followed. More states will soon. Each state has different nuances. Delaware is used by most lawyers for comfort reasons - the law has been in existence longest, they are most familiar with it , and Delaware has long been one of the top domiciles selected for business formation by many large law firms (especially east coast firms or lawyers trained in east coast schools). Having said that, Delaware's corporate statutory system, and its captive insurance statutory system, are among the most sophisticated in the world.
This does not however mean Delaware is the best domicile for you even assuming a Series LLC is determined best for your captive insurance or other new business application. Delaware will however lead and they are very pro-business, have a deep staff and are very competent and friendly. Nevada may also become popular again in the future as Nevada has years of experience with cell captives. Like Delaware, Nevada also has favorable corporate governance statutes and pro-business judiciaries.
As of late 2011, Delaware was not yet charging a new application fee for adding a series or cell to an existing captive (although they are considering one as well as an annual renewal fee as are other states with cell or series entities). Nevada was charging a mere $300 for a new cell in 2011. Neither Delaware or Nevada had required statutory minimum capital for new cells or series, and have through 2011 left that up to the owners/promoters of the "core" entity that paid the required minimum capital to be approved as a captive insurer. The most experienced and professional managers of cell and series captives are requiring reasonable new minimum capital for each cell or series based on the expected annual insurance premium volume that cell or series intends to write.
We expect these fees to soon increase along with minimum capital requirements on new cells or Series LLC SBUs (Special Business Units). Currently the "core" capital suffices which is a huge benefit of a cell or series participant over forming a new captive (generally a minimum $100K capital for offshore and $250K capital for onshore captives). Both Nevada and Delaware reportedly process new applications quickly with friendly service. Ongoing operating cost and complexity variances between these innovative "new wave" domiciles is beyond the scope of this article but covered in detail in our "New Wave" On and Offshore Domicile article.
For asset protection applications, some lesser known offshore domiciles are very attractive.
Tax Considerations
In 2008 the IRS issued a Private Letter Ruling 2008-3004 finding that each series/cell is looked at separately in determining tax treatment of each series for tax purposes as opposed to requiring a consolidated return for the Series LLC. As many questions are created by this Revenue Ruling as addressed by it which is not atypical. Creative uses for Series LLC business structures in the captive industry are just emerging.
State taxation of a Series LLC and cell corporate structure varies. California as of 2006 determined each series/cell must file and pay separately at the state level regardless of whether a federal consolidated tax return was being filed. Other state tax impl;ications vary as well. For example, Delaware and Nevada both apply insurance premium taxes to cell type structured captives on an aggregate basis, meaning each cell or series is not subject to another minimum tax or a separate maximum premium tax. Vermont on gthe other hand indicated an intent to treat cells as separate entities for purposes of applying minimum and maximum premium taxes so as to prevent the use of cell structures to avoid premium taxes. Arizona does not have a premium tax at all, which may attract some larger captives in coming years, yet as of 2011, Arizona did not yet have a admitted cell structured captive.
Conclusions
The asset protection, officer and director fidiciary duty spillover between cells/SBUs, and tax attributes of Series LLCs are not yet fully tested. Uncertainties remain and some litigation in the future likely regardless of the granularity of enabling statutes and careful craftsmanship of lawyers. This explains why Series LLCs are not much more popular already although we expect increasing use as people gain experience and sophistication in this area. The premium tax, formation, capital and administrative efficiency of these advanced structures make them very powerful and a "must know" for any serious captive adviser. To learn more click here.
