Organizational and startup costs for single-member LLCs.

• Author: Colwell, Seth M.
• Position: Limited liability companies

In 1996, Treasury issued the check-the-box regulations (T.D. 8697) and, by doing so, sanctioned the default status of a single-member LLC as a disregarded entity for federal income tax purposes (Regs. Sec. 301.7701-3(b)(1)(ii)). Since these regulations became final, the single-member LLC has increased in popularity among sole proprietors, investors, and other taxpayers. Despite the widespread use of single-member LLCs, some confusion still exists regarding the tax treatment of the initial expenditures to form and operate this type of entity. This item attempts to clarify the rules for organizational and startup costs of single-member LLCs by comparing and contrasting them to the rules for corporations and partnerships.

Organizational Costs

Organizational expenditures are costs incurred to form the entity (Secs. 248(b) and 709(b)(3)). Common examples include legal expenses to draft the formation documents (articles of incorporation, partnership agreement, etc.) and filing fees paid to the state of organization (Regs. Secs. 1.248-1(b)(2) and 1.709-2(a)). Startup expenses are not organizational costs (S. Rep't No. 1036, 96th Cong., 2d Sess., p. 11(1980); Regs. Sec. 1.709-2(a)). Corporations (including S corporations) follow the rules of Sec. 248, while partnerships follow the provisions of Sec. 709. Both sections allow corporations and partnerships to deduct up to $5,000 of organizational costs in the year the business begins and amortize the remainder over 180 months beginning in the month the business begins. If costs exceed $50,000, the $5,000 deduction is reduced dollar for dollar by the excess over $50,000 (Sec. 248(a); Sec. 709(b)(1)). Both partnerships and corporations have the option to forgo the election discussed above and capitalize the expenses (Regs. Secs. 1.248-1(c) and 1.709-1(b)(2)).

What about the organizational costs for single-member LLCs? Unless these entities elect to be taxed as corporations, they are treated as disregarded entities (Regs. Sec. 301.7701-3(b)(1)(ii)). No Code section directly addresses the tax treatment of organizational expenditures for disregarded entities. This lack of guidance raises the question of whether the expenses should be deducted, capitalized, or treated the same as the expenditures for corporations and partnerships.

In 2003, Treasury addressed this issue in regulations for Sec. 263 (T.D. 9107), which require capitalization of the formation costs incurred by disregarded entities (Regs. Sec...