Can I account for start-up costs that occur before incorporation?

Question

I'm starting an LLC with a couple of partners. But before we incorporate we need to finalize a partnership agreement. I would like to initiate a few time-sensitive things such as a patent search before incorporation is complete. These lawyer services will come out of my pocket. Can I include this in our financials as **capital investment** / **start-up costs** once incorporation is finalized? Can I account for start-up costs that occur before incorporation?

Answer 1

Yes, a business can generally account for legitimate costs incurred on its behalf before it is formally organized, but there are two separate questions: how the LLC records your payment and how the expense is treated for tax purposes.

Suppose you personally pay a lawyer $1,000 for work that is genuinely for the future LLC. Once the LLC exists, the books could generally recognize the appropriate business cost and either:

1. record an amount payable to you if the LLC intends to reimburse you, or
2. treat your payment as part of your capital contribution if you and the other members agree that you are contributing the cost to the business rather than being reimbursed.

You should therefore keep the invoice, proof of payment, date, description of the work, and documentation showing that the expenditure was made for the proposed business.

For U.S. federal tax purposes, however, not every pre-opening expenditure is simply a “startup cost.” The tax law distinguishes among start-up expenditures, organizational expenditures, capital expenditures, and other types of costs. Sections 195 and 709 of the Internal Revenue Code contain special rules for start-up and partnership organizational expenses. Certain qualifying costs can be deducted up to a statutory limit, with the remainder generally amortized over 180 months, subject to the applicable rules.

A patent search or other patent-related legal work may require different treatment from ordinary organizational/start-up expenses because costs associated with acquiring, creating, or protecting intellectual property can be subject to separate capitalization and tax rules.

Also, technically an LLC is generally organized or formed, rather than “incorporated.” Its federal tax classification then depends on its circumstances and elections. A multi-member LLC, for example, is generally taxed as a partnership by default unless it elects otherwise.

So the short answer is yes: properly documented pre-formation business expenditures can be reflected in the LLC's records after formation. But do not automatically classify every such payment as either a capital investment or a deductible start-up expense. Record what the expenditure actually represents and whether the LLC owes you reimbursement or treats it as your contribution, and have the tax classification—particularly patent/legal costs—confirmed by the business's accountant or tax adviser.