The limited liability company (LLC) is a popular business entity type for a wide variety of companies. There is actually more than one type of LLC, and sometimes you’ll hear about an LLC being referred to as a “disregarded entity.” What is a disregarded entity, and how do you determine whether your LLC is one or not? Moreover, what does being a disregarded entity actually mean for your business?
In this article, we’ll discuss all the relevant details, including the definition of a disregarded entity, and which types of LLCs fit this description.
What Is an LLC?
First off, let’s quickly outline what an LLC is. A limited liability company mixes elements of sole proprietorships, general partnerships, and corporations, essentially giving entrepreneurs the best of these worlds. LLCs are typically taxed similarly to sole proprietorships and general partnerships, in that the owners include any company profits or losses into their personal returns — the LLC itself does not owe income taxes. An LLC may also elect to be taxed like a corporation, although this is not a very common option.
There are similarities to corporations too, especially when it comes to financial responsibilities. In an LLC, the owners or members are not usually personally accountable for the financial status of the business. This means that if someone sues your LLC, your personal assets are not at risk.
What Is a Disregarded Entity?
In short, a disregarded entity is a business that is not considered to be a separate entity from its owner for tax purposes. When you register your LLC with the state to form your business, the Internal Revenue Service actually doesn’t recognize that LLC as a business that needs to pay taxes.
The IRS considers an LLC to be similar to a partnership if it has more than one owner, in which case it is not a disregarded entity. Likewise, any LLC taxed as a C corporation or S corporation is not a disregarded entity. In order to be viewed by the IRS as a disregarded entity, you must own a single-member LLC that has not chosen corporation-style taxation.
What Does Disregarded Entity Mean for an LLC?
If your single-member LLC is categorized as a disregarded entity by the IRS, your business activities will be indicated on your own personal tax return, and no corporate return will be filed. In this way, the LLC as a disregarded entity is treated exactly the same as a sole proprietorship in terms of taxation.
Most LLCs classified as disregarded entities will need to use the owner’s personal Social Security Number, or the owner’s federal tax ID number (EIN), rather than an EIN held by the LLC itself. However, keep in mind that even if your LLC is a disregarded entity, you will still probably need to get an EIN if you want to hire any employees, or if you’re required to file any excise tax forms.
You should also check with your state to make sure they don’t have any additional requirements for disregarded entities. Some states have different reporting procedures for state-level income taxes for disregarded entities that require special forms.
The Exception to the Rule: Spousal Joint Ownership
There is one way that a multi-member LLC can be categorized as a disregarded entity, which is an LLC co-owned by a married couple. In this situation, the couple has the option to have their LLC treated as a partnership for tax purposes (just like the default setting for all other multi-member LLCs), or it can elect disregarded entity status from the IRS.
There are a couple of rules that need to be followed in order for a married couple to own a disregarded entity. First, the LLC must be owned in its entirety by the couple, with no other co-owners. In addition, the business must be regarded as community property, which means that the LLC is jointly and equally owned by each spouse. Finally, the business must not be categorized as a corporation for tax purposes.
All told, the disregarded entity status basically just means that the Internal Revenue Service will view your LLC as part of your own personal tax return. For the most part, a disregarded entity is just a single-member LLC that has not elected to be treated like a corporation for taxation purposes.
The only common exception to this rule is if a multi-member LLC is owned by a married couple as community property. Even then, there are some additional circumstances that need to be met in order for the LLC to be treated as a disregarded entity.
In general, owning a disregarded entity means that your LLC will be taxed like a sole proprietorship. We hope this article helped you develop your understanding of disregarded entities, and what this status could mean for your business!