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What Is a Disregarded Entity LLC?

A disregarded entity is a type of business entity that is separate from the business owner. Even though this separation exists, the Internal Revenue Service (IRS) disregards the separation for tax purposes.

There are a few business types that the IRS may recognize as disregarded entities. Still, the most common example of a disregarded entity is a single-member limited liability company (single-member LLC).

Key Takeaways

  • A single-member LLC is a business entity owned by one member who has limited liability.
  • The IRS typically recognizes single-member LLCs as disregarded entities.
  • A disregarded entity is a legal entity that is separate from the owner for personal risk purposes but regarded as distinct for tax purposes.

Understanding Disregarded Entity LLCs

Many entrepreneurs are attracted to one popular business structure: the LLC. LLCs are attractive because owners have flexibility and risk protection.

Limited liability means that the owners of the business have protection for their personal assets. Someone who sues the company can't reach an LLC owner's personal assets, such as a car or bank account. This is because an LLC is a separate entity. Sole proprietors, for example, do not have this separation. The owner of a sole proprietorship could be personally liable for business debts.

Single-Member LLCs and Taxes

By default, the IRS recognizes single-member LLCs as disregarded entities. A single-member LLC qualifies as a disregarded entity because only one member owns it, and the member has not chosen a different tax classification.

If the owner of an LLC chooses a different federal tax classification and files tax form 8832, they may be taxed as an s corporation or c corporation. A single-member LLC (or SMLLC) will no longer be disregarded if the owner chooses corporate taxation.

If the owner of an LLC does not choose corporate taxation, then the LLC will be taxed like a sole proprietorship. This means that business income and expenses are reported on the business owner's personal tax return. This is called pass-through taxation. When LLC owners file their individual income tax returns, they will be responsible for employment taxes and excise taxes.

Choosing to be taxed as a corporation rather than a sole proprietorship means that the LLC is no longer a disregarded entity. This is because the IRS taxes the corporation itself. A disregarded entity is separate from the owner for liability purposes but not for federal tax purposes.

What Are the Pros and Cons of Disregarded Entity LLCs?

You may consider pass-through taxation to be a benefit of disregarded entity LLCs. Filing taxes for a disregarded entity LLC is a more straightforward process than handling taxes for a corporation. Owners of corporations have to file a separate return for the corporation, in addition to their tax return. Corporations also have to deal with "double taxation."

Limited liability is an advantage that disregarded entity LLCs have over sole proprietorships. It could be important, though, to keep up with all requirements to ensure that the LLC continues to be recognized as separate from the owner. A creditor could attempt to "pierce the veil" of a disregarded entity LLC so that they could reach the owner's personal assets.

Seeking Assistance

With so much information to learn about business entities, it can sometimes be overwhelming. When you have questions that need answers, consider contacting a local small business attorney. The information they provide can be invaluable to your new business.

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