Are There Tax Deduction Limits for a Limited Liability Company (LLC)?

There are many small businesses established as a single-member LLC (Limited Liability Company). In most cases there was a primary reason for a business owner to use this form of legal organization, and except in a few circumstances special tax treatment was not one of them.

Equally important, for the many individuals contemplating a business start-up or buying a business, the limited liability company structure is probably at least under serious consideration. For those of you who are still making up their mind about a legal form of ownership, detailed discussions with your tax and legal advisors should be a top priority. Although an LLC can have more than one owner (member), my discussion here will focus on the single-member version which is permitted in most States.

It is worth noting that LLC members can be individuals, other LLCs, corporations, or a foreign entity. Two examples of businesses that cannot legally operate as limited liability companies are insurance companies and banks. When there are two or more LLC members, the Internal Revenue Service will treat the LLC as a partnership unless Form 8832 (Entity Classification Election) is filed in order to declare the desire to be treated as a corporation.

Whether or not tax considerations were a secondary issue in your decision to operate as a single-member Limited Liability Company, filing our annual tax returns often raises some new issues and questions. If you have questions about some LLC aspects that you think are unique for your situation, you should have another visit with your tax expert.

As for an answer about the tax deduction limits for an LLC, there are no limits in the strictest sense. The IRS does have tax rules about what assets are actually at risk from losses, and based on the at-risk rules deductions cannot be greater than the assets actually at risk.

With the Internal Revenue Service, there can always be the risk of an IRS audit if reported tax losses appear unusually high. It is somewhat more realistic for a company in its initial year to justify losses in general. Once an LLC has existed for several years, the Internal Revenue Service is likely to review any patterns in losses versus profits. A general IRS expectation is that a business should be profitable for three of every five years.

If an LLC reports losses for three or more years out of a five-year period, it is at risk of being treated as a hobby. The primary tax consequence if this happens is that there will be some additional restrictions imposed on tax losses.