What Is a Disregarded Entity?

A “disregarded entity” refers to an entity with one owner and not organized as an entity such as a corporation, LLC, or partnership. For federal tax purposes, the disregarded entity and the owner, who is a natural person, are not treated separate.

Author: Brad Nakase, Attorney

Email  |  Call (888) 600-8654

How do you determine if an entity is a disregarded entity?

Generally, suppose an LLC has one member (owner) and does not elect to be treated as a corporation by default. In that case, the IRS automatically considers a single-member LLC a disregarded entity. Therefore, there are no steps to take for the LLC to be classified by the IRS as a disregarded entity.

How are small business owners taxed?

A single person who owns a business has a few options when it comes to owning and running a business. An individual may own the business in his or her own name as a sole proprietorship, crate a single-member limited liability company, or set up a solely-owned corporation. The decision regarding what entity structure to use involves a number of factors, one of which is how the business’ income will be taxed.

  • Sole Proprietorship

With sole proprietorships, there is no separate entity, meaning the business’ income is the individual owner’s income and is therefore documented on Schedule C.

  • Corporation

A corporation that is solely owned can be taxed as a separate legal entity and will pay taxes on its income. This form of taxation is referred to as C corporation taxation.

If the shareholder so desires, and his or her corporation meets the requirements, then the company may be taxed as an S corporation. In this case, the company’s income will “pass through” to the shareholder.

  • LLC

A single-member LLC owner has a choice when it comes to taxation. The IRS will, by default, classify the LLC as a disregarded entity. In essence, the company will be treated like a sole proprietorship for federal income tax purposes. If the owner wishes, however, he or she may choose to have the LLC taxed as a corporation. In this case, the LLC will not be a disregarded entity.

If an individual is interest in creating a single-member LLC that will be a disregarded entity, he or she should consider the following advantages and disadvantages, as well as regulations and rules.

What are the pros and cons of a disregarded entity?

  • Easy Filing Process

One of the greatest benefits of running a single-member LLC disregarded entity is that the tax filing process is much simpler than it is for corporations. For instance, a corporation’s sole shareholder needs to file a separate return for the company in addition to their own tax return.

  • LLCs Have Limited Liability

Another advantage of having an LLC rather than a sole proprietorship is limited liability. While an LLC is a disregarded entity only for tax reasons, it is notable that an LLC is a separate entity responsible for its own responsibilities and debts.

The sole owner of an LLC is not liable for these debts or obligations, meaning that a creditor will have to turn to the company rather than the individual. Conversely, a sole proprietorship does not have any legal existence whatsoever. This means that the business’ debts are the owner’s as well.

  • LLCs and Corporations Are Different

There are a number of factors besides taxation to consider when choosing between forming a corporation and an LLC. For instance, an LLC is typically easier to manage, but it can be easier for corporations to get funding.

  • LLCs Are Not Disregarded for Other Tax Purposes

A single-member LLC is only a disregarded entity for income tax purposes. However, it is not disregarded for employment tax, sales tax, excise tax, or franchise tax.

This is important to know because corporations and LLCs are regarded quite differently when it comes to self-employment taxes.

Is a single-member LLC a disregarded entity by default?

By default, a single-member LLC is classified as a disregarded entity by the IRS.

That said, the owner of an LLC may choose to have the company be treated as a separate entity. To do this, he or she should file Form 8832 (Entity Classification Election) with the IRS.

Does A single-member LLC require AN EIN?

A single-member LLC does not need to obtain an EIN unless it has employees or files excise tax returns.

That said, it may be useful to get an Ein for other purposes, such as opening a business bank account in the name of the LLC. Also, some companies may require than a business have an EIN before they process payments.

Can a disregarded entity have 2 members?

A multi-member LLC is not considered a disregarded entity. An LLC that has at least two members is classified as a partnership for income tax reasons. The company may choose to file a Form 8832 (Entity Classification Election), which would mean it would be taxed as a corporation. For this, it will also have to submit Form 1065, the U.S. Return of Partnership Income.

That said, if the LLC is owned by a married couple that lives in a community property state, then the jointly-owned company may be considered a disregarded entity for tax purposes – if the following is true:

  • The LLC is completely owned by each spouse as community property according to state law
  • There are no other owners reported on federal tax returns
  • The business is not considered a corporation according to federal law

How a single-member LLC becomes a disregarded entity?

By default, the IRS treats a single-member LLC as a disregarded entity. This means that a business owner does not have to take any steps to have his or her LLC classified as a disregarded entity for tax purposes.

When tax season comes around, the IRS will not regard the LLC as a separate entity from the business owner. This means that the company’s profits, losses, and credits will be represented on the owner’s individual federal tax return.

Please tell us your story:

2 + 0 = ?

See all blogs: Business | Corporate | Employment

Material Breach of Contract

A material breach of contract occurs when a party fail to perform a contract's terms making the primary purpose of the contract not met, the breach is considered material.

What Type of Business Is a Partnership?

A partnership is the simplest business structure where two or more people are owners of a business. The types of business partnerships include general partnership, limited partnership, and limited liability partnership.

What Is Company Culture?

A company culture is how things get done in the workplace. Company culture can more be described as core values or operating principles used to set the tone for the company's overall operations and success.

What is a sole proprietorship?

A sole proprietor is someone who owns an unincorporated business by himself or herself. A sole proprietorship is a business that can be owned and controlled by an individual.

Sole Proprietorship vs. LLC

Sole proprietorships are popular for self-employed professionals, freelancers, and contract workers, while LLC offers personal liability protection than sole proprietorship.

Is it legal to sell homemade food in California?

Yes, you can sell food from home so long as you have California-required health and food handling permits and business licenses. You must get a permit to sell food from home from the county health department in California. 

How to Incorporate a Small Business in California?

To incorporate a small business in California, file an Articles of Incorporation with the California Secretary of State's office. After you file the Article of Incorporation, create corporate bylaws, and elect your initial director(s).

6 Steps for Planning a Business Grand Opening

1. Create Goals for the Event, 2. Begin Planning Early, 3. Stick to the Budget, 4. Have the Right Insurance, 5. Advertise Before the Event, 6. Offer Food and Entertainment

10 Facts About Business Before Starting A Business

1) More than 50% of new businesses survive their first year in business. 2) Less than 50% of family-owned businesses are passed to their children. 3) 40% of business experience challenges in the supply chain…

S Corp vs C Corp – Differences and Benefits

The main difference between an S Corp and a C Corp is that for a C Corp, the corporate profit is taxed to the company, and the dividends to the shareholders are also taxed. In contrast, for an S Corp, the profit is taxed to the shareholder but not to the corporation. Generally, small businesses are S Corps, and major companies are C Corps, e.g., Apple, Microsoft, Caterpillar, John Deer, etc.

How to Form a Corporation in California?

To form a corporation in California follow these steps: 1) Write a one page Article of Incorporation, 2) File the Article of Incorporation with the California Secretary of State, 3) Elect corporate board of directors, 4) File Statement of Information with Secretary of State.

What are the benefits of a corporate lawyer?

The are many benefits of hiring a corporate lawyer for your business which includes: avoiding litigation, enforceable contracts, develop employee policies, proper licensing, etc.

What is Commercial Litigation?

Commercial litigation refers to litigation (lawsuit) that involves commercial or business disputes in court between two or more parties.

How to Get Rid of a 50 50 Business Partner.

How to Get Rid of a 50/50 Business Partner. One method to get rid of a 50/50 partner is to file a business partnership dissolution in the state your company was formed to end the partnership.

Personal Assistant Scam

A personal assistant scam typically involves a perpetrator putting out an ad to hire a personal assistant. Then, when the perpetrator purportedly hires the personal assistant, the assistant is asked to buy something with their own money with the promise to be repaid. The perpetuator then disappears after receiving the goods.

Fiduciary Responsibility Definition

A fiduciary responsibility refers to an organization that must put another person’s best interest first. A fiduciary duty is the highest standard of care in law. For example, a lawyer owes a fiduciary responsibility to the clients, a doctor owes a fiduciary duty to a patient, and a trustee owes a fiduciary duty to a beneficiary.

What is profit formula and how to calculate profit formula?

A business profit is revenue minus expenses. The profit formula in accounting calculates the net gains or losses incurred by the business for a period by subtracting the total expenses from the total income: Total Income – Total Expenses - Profit

What is invoice reconciliation?

Invoice reconciliation is the process of matching bank statements to incoming and outgoing invoices. The purpose of invoice reconciliation is to confirm that the data entry is correctly matched with every invoice.

What Makes a Verbal Contract Valid

A verbal contract is valid when contractual elements are satisfied, such as evidence of an offer, acceptance of the offer, and consideration which is an exchange of value between the parties.

Marketing Transport Company

The easiest way of growing your list of clients is to schedule a meeting with businesses that do a lot of shipping and introduce your transportation company. Then, engage an internet presence to market your transportation business.

What Can You Do with a Toxic Business Partner?

A bad partnership could lead to profit loss and toxic company culture. The first way of dealing with a toxic business partner is to schedule a meeting to discuss your concerns calmly.

Disruptive Business Model

Disruptive business models are disruptive innovations that bring new business ideas or technology to existing markets. A disruptive business does not fit the profile of a standard business model. Amazon is considered as one of the world's most disruptive companies.

How to Get a Business Loan with Bad Credit

For small business owners with bad credit, the easiest place to get a business loan is with the SBA. Although not easy, entrepreneurs with bad credit can get a small business loan.

How to Get a Small Business Grant

You can get a small business grant from the Small Business Administration. Also, check your local government for small business stimulus grants.

Pros and Cons of Etsy

Etsy Pro: Your products are given a large audience, and you easily sell your merchandise. Etsy Cons: You can only sell handmade or vintage merchandise, and there are many competitors.

What is a Breach of Contract in California?

A breach of contract in California arose when a party to a contract failed to achieve a legal duty the contract created. When a party to a contract fails to fulfill the terms of a binding contract, they are liable for damages for breaching the contract.

Business Equipment Leasing Pros and Cons

One advantage of equipment leasing is that you don’t need to come up with all the cash to buy the equipment. One disadvantage of equipment leasing is higher overall costs than outright purchasing the equipment.

LLC vs DBA

The main difference between an LLC and a DBA is that an LLC is a business entity, and a DBA is a registered fictitious business name. Sole proprietors, general partnerships, and LLC can register for a DBA.

See all blog: Business | Corporate | Employment

© Copyright | Nakase Law Firm (2019)