Single-Member LLCs Have Special Tax-Advantages

Are you familiar with single-member limited liability companies (SMLLCs)? As you might expect, an SMLLC is an LLC with only one member or owner. The member can be a corporation, a partnership, a multi-member LLC, another SMLLC or even an individual. Here's an important point: Due to an unfavorable 2004 tax law change, SMLLCs can be the best type of legal entity for expanding an existing business operation if you open up additional locations. The growth may come from:

Tax Rule Makes SMLLCs More Attractive

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In all three cases, the SMLLC can save taxes. This is because setting up one or more SMLLCs to own the expanded operations allows your business to avoid a new tax rule that generally requires you to capitalize most pre-opening expenditures (costs incurred in advance of when the expanded operations are up and running) and amortize them over 15 years. Naturally, you would prefer to immediately deduct the pre-opening expenses, and using an SMLLC can allow you to do just that.

We'll explain how, but first, a little background information. In general, you can immediately deduct most pre-opening expenditures incurred to expand an existing line of business — as opposed to starting up or acquiring an entirely new business — under Section 162 of the Internal Revenue Code. However, there's an unfavorable exception for pre-opening costs to expand an existing business when you use a separate legal entity to own the expanded operations. If the separate entity is a corporation (it makes no difference if it's an S or C corporation), you must capitalize and amortize most pre-opening expenses under Section 195 of the Internal Revenue Code.

In the past, this tax treatment wasn't very painful, because the amortization period for the capitalized amounts was only five years. This was considered an acceptable price to pay for the liability protection advantages of using a separate corporation to own the expanded operation. Unfortunately, however, the American Jobs Creation Act of 2004 changed the amortization period for pre-opening expenditures in excess of $5,000 to 15 years. Now that's painful! The unfavorable rule applies to pre-opening expenditures incurred after October 22, 2004.

Now for the Good News

For federal tax purposes, a single member limited liability company doesn't count as a separate legal entity. Instead, the SMLLC's existence is disregarded for tax purposes, and it's simply treated as an unincorporated branch or division of the member (or as a Schedule C, E or F activity if the member is an individual). This means no separate federal tax filings are required for the SMLLC's business operations. (In most cases, this simple treatment applies for state tax purposes too.) This means when you set up an SMLLC to own an expanded business operation, you can immediately deduct most pre-opening expenditures. Obviously, that's a much better deal than having to capitalize them and write them off over 15 years. (IRS Regulations 301.7701-1-, -2, and -3)

As for the liability protection issue, an SMLLC will generally protect its member from liabilities related to the expanded business operation in essentially the same fashion as a corporation. So you get the desired corporate liability protection while avoiding the unfavorable capitalization and amortization tax rule that would otherwise apply to pre-opening expenditures.

Still More Good News...

If the member wants to take money or assets out of an SMLLC, there are no federal income tax complications, because the entity doesn't exist in the eyes of the IRS. Do you want to move money or assets into the SMLLC? No problem here either, because the member is essentially treated as making transactions between itself and itself. Such moves have no federal tax significance.

In contrast, establishing a corporation, limited partnership or multi-member LLC to own the expanded operation triggers the unfavorable 15-year capitalization and amortization rule and can create numerous other tax complexities involving moving assets.

To sum up, an SMLLC is "invisible" for federal tax purposes while still providing liability protection to its member, pursuant to your state's LLC laws. The big tax advantage of the invisibility factor is it allows you to avoid the unfavorable rule that would otherwise require capitalization and amortization for pre-opening expenditures (in excess of $5,000) incurred to expand your existing business.

Caution: Consult a knowledgeable business attorney regarding liability issues before making a final decision about what type of legal entity to use for your expanded business operations.

Note: You must capitalize the costs of establishing an SMLLC — which are typically the legal expenses and a registration fee paid to the state — if these organizational expenses exceed $5,000. No amortization is allowed for capitalized amounts. Under a favorable exception, however, SMLLC organizational expenses can be immediately deducted under Section 162 of the Tax Code if they amount to $5,000 or less, which will often be the case. (IRS Regulation 1.263(a)-5)

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