When you start your business, you must choose a business structure. If you set your business up as a limited liability company (LLC), the IRS treats your business as a corporation, partnership, or a disregarded entity.
What does disregarded entity mean? Let’s take a closer look.
What is a disregarded entity for tax purposes?
A disregarded entity is a single-member LLC. An LLC is typically considered as a separate entity from the owners. However, an LLC with only one member is disregarded as separate from its owner for income tax purposes. This means that you and the business are combined for income taxes. The LLC will remain a separate entity for employment taxes and certain excise taxes.
A disregarded entity is all about how a business files its taxes.
Disregarded entity taxes
With a disregarded entity, the business is separate from the business owner in some cases, and together with the business owner in others.
The business is with the business owner for income taxes. File business taxes on Form 1040 Schedule C.
A disregarded entity remains separate from the owner for the following taxes:
- Employment taxes
- Excise taxes reported on Forms 720, 730, 2290, 11-C, and 8849
How to become of disregarded entity
If you own a single-member LLC, you don’t need to make any special elections to be a disregarded entity. The IRS will automatically consider the business as a disregarded entity. Simply file your business taxes on Form 1040 Schedule C.
You only have to worry about making an election if you don’t want the business to be a disregarded entity. You can file Form 8832 and elect to have the IRS treat your business as a corporation.
If a business is a partnership and the number of owners reduces to one, the business will become a disregarded entity. If a disregarded entity ever adds members, it will become a partnership.
Businesses that cannot be a disregarded entity
Only single-member LLCs can be disregarded entities.
LLCs with more than one owner cannot be disregarded entities. However, some states allow for community property between spouses. If a business is owned exclusively by spouses in a state that allows community property, the business can become a disregarded entity. In states without community property laws, the LLC has to file as a partnership.
Corporations, including S Corps, are not disregarded entities. Also, sole proprietorships are not disregarded entities because they are not separate from the owner in any situation.
Advantages of being a disregarded entity
You might choose to make your business a disregarded entity LLC for several reasons.
Doing so can help protect personal assets from lawsuits or small business bankruptcy.
You might also choose to make your business a disregarded entity simply because it makes business entity tax preparation much easier and cheaper. Rather than filing separate business and personal taxes, you will claim all business income and expenses on Schedule C (Form 1040) and attach the schedule to your personal tax form.
Whether your small business is an LLC, sole-proprietorship, or corporation, you need an easy-to-learn, reliable, and convenient way to keep your records. Take a look at Patriot Software for affordable online accounting software.
This article is updated from its original publication date of 8/18/2015.