Disregarded Entity
U.S. tax and compliance regulations are notoriously complex, often filled with obscure terms such as “disregarded entity. In this article, we’ll demystify what disregarded entities are and why they matter to your business. We’ll clarify what types of businesses fall under this classification and provide an overview of other business structures to ensure you have a comprehensive understanding of your options as a founder.
What is a disregarded entity?
A disregarded entity (DE) is a tax and accounting term that refers to a business that is not considered by the IRS for tax purposes. Instead of being subject to corporate income tax, the business’s income is taxed as the owner’s personal income.
In essence, disregarded entities are taxed as if the business hadn’t been formed at all. There are several types of disregarded entities available for tax purposes. Here are some of the most common.
Single member LLC (SMLLC)
The single-member LLC is the most common type of disregarded entity. The IRS automatically taxes this structure as a disregarded entity, eliminating the need to file Form 8832 .
It’s important to note that while income tax applies only to the owner, the LLC is still taxed as a separate entity for employment and certain excise taxes, if applicable.
Jointly owned LLC
Less commonly, an LLC owned by two spouses may qualify as a disregarded entity if it operates in a state with community property laws. For the entity to qualify for this tax status, the IRS requires three conditions:
1. The entity is wholly owned by a husband and wife as community property under state law.
2. No individuals other than the spouses are considered owners for tax purposes.
3. The entity is not treated as a corporation under IRC §301.7701-2 .
Pass-through entities
While not classified by the IRS as disregarded entities, business structures that pass income directly to the owners achieve a similar result. By attributing the income of the business solely to the owners, these entities avoid being taxed themselves and only the owners are taxed.
Here are some of the most common structures:
- Sole Proprietorship
- S-Corp
- Partnership
What are the benefits?
Choosing a business model that qualifies for taxation as a disregarded entity offers several significant benefits that may not otherwise be available. Here are three of the most notable.
No double taxation
Certain business structures result in separate taxation of the owner and the business, resulting in double taxation. This includes paying corporate tax on business income and personal income tax on wages. However, with a disregarded entity or other pass-through entity, only the owner is subject to taxation.
Less liability
LLCs, unlike sole proprietorships, provide owners with limited liability protection. This effectively limits the ability of courts, creditors, and other adverse parties to seize the assets of the business owner. However, this protection assumes that no personal guarantees have been made, as these would make the owner personally liable.
Discover more about LLCs and sole proprietorships in our comprehensive guide .
Easier tax filing
Since income is passed through to the owner for tax purposes, only one tax return needs to be filed each year. Doing your own taxes means less paperwork and more time to focus on growing your business. Alternatively, if you outsource your taxes, you’ll likely incur lower fees compared to those who file multiple returns.
What about other business structures?
We’ve discussed various disregarded entities and their benefits, but what about other business structures? How are they taxed?
Multi-member LLC
Multi-member LLCs cannot qualify as disregarded entities, but they retain flexibility during tax season. A multi-member LLC is taxed as a partnership by default unless it files Form 8832 and elects to be taxed as a corporation.
Discover more about single-member LLCs and multi-member LLCs in our comprehensive guide .
C-Corp
C-Corps are required to file taxes as corporations and lack the flexibility enjoyed by LLCs. This often results in double taxation, as the corporation itself is taxed in addition to any individual shareholders who receive dividends.
Conclusion
Choosing a business structure that is treated as a disregarded entity allows for strategic tax planning that can result in savings for business owners. With inflation and interest rates continuing to rise, maximizing the value of your dollars is critical.
Incorporating an LLC provides essential liability protection while offering the ability to file taxes as a disregarded entity. Ready to incorporate your business? Startxpress can help you incorporate your LLC or C-Corp in just minutes.
For more details, check out the Startxpress Help Center and Blog. If you need assistance, contact us at support@startxpress.io! We’re here to help make managing your business as smooth as possible.
Related Articles
- How are LLCs taxed?
- LLC vs. C-Corp: How To Choose What’s Best For You
- Single-Member vs Multi-Member LLC
- Wyoming C-corp or Delaware C-corp
- What are the benefits of Wyoming LLCs?
Was this helpful?
0 / 0