Do Single-Member LLCs Need to File Tax Returns in Chapter 11 Cases?

November 4, 2021

Close up view of the income tax returnBy Steven R. Kinsella

Unless the owner of a limited liability company elects to be treated as a corporation for tax purposes, the IRS will treat a single-member LLC as a “disregarded entity” for tax purposes. As a disregarded entity, an LLC’s assets, liabilities, income and deductions are reported as belonging to the owner for tax purposes. Markell Co. v. Comm’r Consequently, a single-member LLC that has not made the election to be treated as a corporation does not normally file its own tax return; instead, the single-member owner files a tax return listing the LLC’s assets, liabilities, income and deductions. Often, especially when the owner of the LLC is itself just a holding company, the LLC will pay for the preparation of the tax return as a business expense.

However, what happens when a single-member LLC files a chapter 11 case and the owner of the LLC does not? If a debtor fails to file a tax return that becomes due after commencement of the case, the Bankruptcy Code requires the conversion or dismissal of the case. 11 U.S.C. § 521(j). Consequently, it is routine for a chapter 11 debtor to file an application to employ an accountant for preparation of the tax return. But, if the debtor is a single-member LLC that has not elected to be treated as a corporation, does section 521(j) apply for a federal tax return? If an accountant is retained to prepare a tax return that is actually for the non-debtor owner of an LLC-debtor, is the accountant entitled to an administrative expense claim against the bankruptcy estate?

Unfortunately, no court has specifically addressed these issues. However, courts’ decisions addressing related issues indicate that a single-member LLC is not responsible for filing a federal tax return and an accountant preparing a tax return of the non-debtor single member would not be entitled to an administrative expense claim.

For instance, in In re Conex Holdings, LLC, the bankruptcy court determined that any tax benefits attributable to a single-member LLC were owned by the single-member owner and did not become property of the estate.  The bankruptcy court based its decision on the treasury regulations, which provide that the assets, liability, income and deductions of an LLC treated as a disregarded entity are reported as belonging to the owner for tax purposes.

Similarly, in In re Horizon Grp. Mgmt., LLC, the bankruptcy court rejected an attempt by the IRS to assert a claim against a debtor for the tax liability owed by the debtor’s single-member owner attributable to the debtor’s income. The bankruptcy court held that the debtor was not liable because it was a disregarded entity.  

In In re Das A. Borden & Co., the Eleventh Circuit upheld the denial of an administrative expense claim for an accounting firm that provided services to a debtor’s non-debtor subsidiaries. When evaluating whether the accounting services were necessary for the preservation of the estate, provided a benefit to the debtor and were fundamental to the debtor’s business, the Eleventh Circuit determined that any benefit to the debtor was incidental at best and the accounting firm was not entitled to an administrative expense claim.

As the case law indicates, it is unlikely that a single-member LLC would be required to file a tax return to comply with 11 U.S.C. § 521(j) or that an accounting firm preparing a tax return for the single-member of the LLC would be entitled to compensation from the bankruptcy estate for providing such services. However, from a practical perspective, the owner of an LLC debtor is normally important for the bankruptcy case and may want the bankruptcy estate to cover the cost of preparing the tax return. One solution would be to make the corporate election prior to the bankruptcy filing, which would require the debtor to file a normal corporate tax return, alleviating the need for the owner to file a tax return moving forward, but that does not solve for pre-election tax returns that may be incomplete. Another solution may be to structure the preparation of the tax return as compensation for the owner’s services in connection with the bankruptcy case (or assigning any tax benefits to the estate in exchange for the estate covering the cost of preparation of the tax returns)–more clearly demonstrating value to the bankruptcy estate. Finally, if the single-member owner is a holding company, you may consider filing a bankruptcy case for the single-member owner as well. As a debtor, the single-member owner would be required to file a tax return under 11 U.S.C. § 521(j) and it may be easier to justify retention of an accountant on behalf of both estates. While none of these solutions is perfect, it is important to consider these issue prior to commencing a case and seeking retention of an accountant to prepare tax returns for a single-member LLC.

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