Deducting Organizational Costs for Single-Member LLCs
Many people who start one-owner businesses form single member limited liability companies (LLCs) to own and operate the business. Single-member LLCs are legal in every state. However, for tax purposes they are “disregarded entities”—this means that a single-member LLC is treated the same as a sole proprietorship unless the LLC owner elects to have the LLC treated as a corporation (which is rare).
Being treated as a disregarded entity generally creates no special problems for one-owner LLCs. However, special rules do apply to the ability to deduct organizational expenses for a single-member LLC.
Organizational expenses are the costs you incur to form your LLC, including legal fees for drafting an LLC articles of organization and operating agreement, accounting fees for setting up the LLC and its books, state LLC fees, and other filing fees.
Organizational expenses are capital expenses that ordinarily are not currently deductible in a single year as business operating expenses. However, a special tax provision allows such expenses to be deducted in a single year by corporations and owners of LLCs and partnerships with two or more members. Such businesses may deduct up to $5,000 of organizational costs in the year the business begins and amortize (deduct) the remainder over 180 months beginning in the month the business begins. If organizational costs exceed $50,000, the $5,000 deduction is reduced dollar for dollar by the excess over $50,000. (IRC Sec. 248(a), 709(b)(1).)
These tax law provisions do not apply to one-person LLCs, because they are disregarded entities. The IRS says that one-person LLCs may deduct in a single year organizational costs that do not exceed $5,000. However, if a single member LLC’s organizational expenses exceed $5,000, no portion of the expenses is deductible. Instead, the entire amount must be capitalized. This means they would not be deductible until the LLC is dissolved. (Treasury Regs. Secs. 1.263(a)-5(d)(1) and (3).)
Example 1: Larry forms a single-member LLC to run his consulting business. He incurs $800 in expenses for the llc operating agreement, articles of organization, and filing fees. Since these expenses are below the $5,000 threshold, he may deduct the entire amount the first year the LLC is in business.
Example 2: Assume that Larry incurs $6,000 in legal expenses to set-up his one-member LLC. Since this amount is over the $5,000 threshhold, none of these organizational costs are deductible or amortizable. Larry must capitalize the $6,000 expense. These costs will only be deductible upon the LLC’s dissolution and termination.
The moral is that if you form a one-member LLC, you should never spend more than $5,000 in organizational expenses. For the great majority of one-member LLCs, this should not pose a problem.