A disregarded entity refers to a business that is independent of its owner but is disregarded for federal tax purposes.
This sounds like a double negative. This means that the tax-related business is not separate from the owner. The owner pays taxes as part of his income tax return.
Information about the Disregarded Entity
Although LLCs can be registered in a state as a legal entity, the IRS does not recognize them for tax purposes. If there is more than one owner (partner), it considers an LLC partnership. It also considers a sole proprietor if there is only one member.
The legal separation between a company and its owner(s), separates the liability of that business in the event of lawsuits and other debts. Limited liability companies, partnerships, corporations, and corporations are distinct entities from their owners.
The only entity to be ignored: A single-member LLC
According to the IRS, an LLC that has only one member is considered a single-member LLC (SMLLC), for income tax purposes.
A Single-Member LLC can be considered a separate legal entity. However, it is subject to tax through the owner’s tax returns, using Schedule B for business income.
How to Choose to be a Disregarded Entity
You don’t need to do anything to become a disregarded entity. Simply file your LLC taxed as a single member using Schedule C. You can also include your net income and loss in your income tax return.
Single-member LLCs and Employer ID numbers
Your social security number (SSN), if your LLC has more than one member, can be used for income tax purposes.
An EIN is not required for a single-member LLC without employees or tax liability. For federal tax purposes, it should use the tax ID number of the owner. For federal tax purposes, it should use the tax ID number of its owner.
A single-member LLC can apply for an EIN via FormSS-4, but no box allows you to choose disregarded entity status. Item 8a will ask if the business has an LLC. If the answer is “yes”, Item 8b will ask for the number of members.
If you are applying for an EIN for your business because you have employees or must pay the excise tax, you should check line 9a (“Type of entity”) and write “Disregarded entity” (or “Disregarded enterprise-sole proprietorship” for individuals. For more information, see the instructions for Form SS-4.
Do not forget about state income tax
You may need to review the income tax reporting requirements if you have a single-member LLC that is disregarded. Several states require you to use a particular form to report your business taxes to your tax return. 6
Disregarded Entities, Employment Tax
Employment taxes are not affected by the disregarded entity status for a single-member LLC. To report and pay employment taxes, the LLC must use its employer ID (EIN), and name. To register for excise tax activities, you must also use your EIN as a business. 7
Liability issues for a Disregarded Entity
Disregarded entities are considered to be the same entity as their owner, but not for tax purposes. LLCs are legal entities. The entity operates within state laws so it doesn’t have any liability.
Two-Spouse Businesses: A Special Case
Federal tax rules allow for the disregarded treatment of a business owned by two spouses. This is called a Qualified joint venture by the IRS. It allows spouses to file two Schedules C’s and split the net income between them.
This option is not available to couples
- In a community property State
- If the spouses are the sole owners
- The business will not be taxed as a corporation 8 9
Are these other business types considered to be separate entities?
The state regulations that govern the establishment of businesses are administered by the secretary of state. No state recognizes “disregarded entities” as business types. Take a look at the different legal types of businesses to see how they compare to the requirements to be considered a disregarded entity.
- In which the sole proprietorship and the business are one entity. Schedule C taxes the sole proprietorship, but you don’t have a separate entity that can provide liability protection in case the business defaults or is sued.
- A multi-member LLC has been registered with the state. This business type offers liability protection and pays income taxes like a partnership.
- As noted above, a partnership is not considered a disregarded entity (including limited partnerships or limited liability partnerships) as partnership taxes are not included in Schedule C. Partnerships pay income tax in particular ways.
- A corporate is an independent business entity. It provides liability protection and pays taxes on Form1120.
- A subchapter is a corporation. It provides liability protection and files an information return on Form 1120-S. The owners are subject to tax on their income tax returns, but not on Schedule C.