Updated on April 18th, 2023
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
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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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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:
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.
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