What is a disregarded entity?

Despite its name, every business owner should be aware of what a disregarded entity is. This essential tax-filing concept applies to many single-member businesses in the United States.

Filing as a disregarded entity for tax purposes simplifies reporting and impacts liability protection. This guide will explain disregarded entities, which businesses qualify, and the pros and cons of filing as one. 

What is a disregarded entity? An LLC tax crash-course

A disregarded entity is a business that the Internal Revenue Service (IRS) treats as part of the owner’s tax return. The business owner reports a disregarded entity’s income and expenses on their personal tax return. Still, the entity is considered separate for certain taxes, such as employment tax.

Only specific business structures (such as single-member LLCs) are considered disregarded entities for tax purposes. Qualifying business entities are disregarded by default unless the owner elects to treat it as a corporation. 

What businesses qualify as disregarded entities?

Wondering whether you can claim your business’s income on your personal tax return? Here are some typical disregarded entity examples:

• Single-member LLC: A business with only one member (aka owner) who pays the business’s taxes on their personal income tax returns.
• Qualified joint venture: A business owned by a married couple that operates in a community property state, such as Arizona, California, or Washington.
• Qualified real estate investment trust (REIT) subsidiary: A QRS has a single owner—an REIT. Under most circumstances, it is disregarded.
• Qualified subchapter S subsidiary: A qualified subchapter S subsidiary is wholly owned by an S corp, making it a single-member business. Exceptions apply for certain filings, depending on jurisdiction.

These business entities are considered disregarded entities by default unless they elect to be treated as corporations.

Note that a sole proprietorship (aka a single-owned business) is not a disregarded entity, even though income is reported on the owner’s federal tax return. Essentially, a sole proprietorship is not considered a separate entity at all, so there’s nothing to disregard.

Advantages and disadvantages of disregarded entities

Disregarded entities provide administrative and financial benefits, but they also come with limitations and legal complexities. Here are the pros and cons of this federal tax status:

Pros

• Simplified tax-filing process: Tax administration is much simpler because the owner only needs to file one income tax report for themself and the business. Single-member businesses are small and often operate without an accounting department to handle business taxes. A disregarded entity saves the business owner from the headache of filing additional business returns and the money required to outsource accounting.
• Owner liability protection: A single-member LLC provides legal protection for the owner and the business. One is typically not held liable for legal action taken against the other. Despite a combined federal income tax return, the owner’s assets are considered separate from the LLC’s.
• No double taxation: A C corporation is subject to corporate income tax, and its owners are also taxed when they receive dividends. Conversely, a disregarded entity’s income is only taxed once.
• Flexibility: A single-member LLC is automatically considered a disregarded entity, but the owner can choose how it’s taxed. They can file a Form 8832 with the IRS and elect to be taxed as a corporation.
• Independent business management: A sole owner can make decisions for their business without running them by someone else. Notably, this isn’t true of qualified joint ventures between married couples in community property states.

Cons

• Limited ability to raise capital: Disregarded entities may struggle to raise capital, as they cannot retain their single-member status if they sell ownership stakes.
• Responsibility for employment taxes: The owner is responsible for paying payroll taxes throughout the year for employees—Medicare, Social Security, and the Unemployment Trust Fund (mandated by the Federal Unemployment Tax Act). The entity is treated as a corporation for these taxes. Independent contractors do not incur employment taxes for the hiring entity.
• Industry tax: Disregarded entities are also treated as separate from their owner for specific excise tax purposes. Industries subject to excise taxes include crude oil, tobacco, and alcohol.
• Complex legal requirements: Although federal income tax filing is simple for disregarded entities, their legal classification is complicated and narrowly defined. Expert assistance means additional expenses.
• Restrictions on business changes: Single-member LLCs can’t add another owner without losing disregarded entity status. This status could also be threatened if a joint venture between spouses moves to a state that doesn’t recognize community property.

How are disregarded entities taxed? 

Disregarded entities are taxed similarly to sole proprietors, which are pass-through entities (businesses taxed at individual rates). 

Disregarded entities pay various taxes, including the following:

• Self-employment tax: This rate is 15.3% as of 2024.
• Personal income tax: This rate depends on your tax bracket.
• Employment taxes: Businesses pay half of Social Security and Medicare taxes for each employee’s salary, plus the entirety of FUTA taxes.
• Excise taxes: Paid only in certain industries.

Several forms and schedules are crucial during tax filing for owners of single-member LLCs: Schedule C, which you file with Form 1040: U.S. Individual Income Tax Return, and Schedule 1: Additional Income and Adjustments to Income.

• Schedule C: For reporting total business income, expenses, and profits. 
• Schedule 1: Information from Schedule C is added to line 3 of Schedule 1.
• Form 1040 (U.S. Individual Income Tax Return): All information in Schedules C and 1 are reported here.

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FAQs

Still have questions? We can help.

Is an S corp a disregarded entity?

No, an S corporation isn’t a disregarded entity, although they share some similarities. For example, an S corp is a pass-through entity. However, it’s still considered legally distinct from its owner at the federal level.

An S corporation must file its own tax return. The owner doesn’t report corporate income on their personal income tax return.

Does a disregarded entity need an employer identification number? 

A disregarded entity only needs an EIN under certain circumstances.

• If it employs one or more people. Any business entity that pays payroll taxes needs an EIN.
• The same rule applies to certain excise taxes.
• Any entity with a pension plan must have an EIN according to instructions on Form SS-4: Application for Employer Identification Number.

How can a disregarded entity elect to be taxed differently? 

A disregarded entity can be taxed differently if it elects to change its tax classification. It can file Form 8832 and change to a corporation. The IRS will treat the owner as if they’ve contributed all assets and liabilities to the corporation in exchange for stock. 

It’s also possible to change back from a corporation to a disregarded entity, but generally, not less than 60 months after the original change was made.

Does a disregarded entity need a bank account? 

No, a disregarded entity doesn’t need to open a bank account. However, it’s wise to keep personal and business funds separate. This helps maintain the liability protection afforded by an LLC. 

If you want to open a business bank account, you’ll need an EIN. 

Is an LLC owned by another LLC a disregarded entity?

This depends on the tax status of the LLC that owns it. If one person owns the owning LLC, then the owned LLC may be treated as a disregarded entity. However, if the owning LLC has multiple members, then the owned LLC can’t be a disregarded entity and is treated as a division of the owning LLC.

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