Krisztina Papp on Unsplash Disregarded Entity LLCs: Meaning and How to Start One in 2022
If you are the owner of a single-member limited liability company (SMLLC), then the IRS will classify you by default as a "disregarded entity". However, you will have the unique choice of being treated as a corporation or as a disregarded entity.
As its name suggests, limited liability companies segregate company assets from the owner's personal assets. This kind of company formation keeps personal assets safe (limits your liability) in legal scenarios where business assets are in jeopardy. In addition to this advantage, SMLLCs are able to avoid double taxation.
In this guide, we will break down what this all means and see how being a disregarded entity may be beneficial to you and your single-member LLC in 2022.
Pros and Cons of Disregarded Entity LLCs
Pros: Avoid double taxation faced by regular corporations while still maintaining limited liability not afforded to sole proprietors.
Cons: The company is still liable for employment and excise taxes and is barred from bringing on additional owners.
What Does a Disregarded Entity LLC Mean?
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A disregarded entity is a business that:
- has a single owner;
- is not organized as a corporation;
- has not asked the IRS to classify them as a separate entity for federal tax purposes.
When an LLC’s status is "disregarded" for federal tax purposes, this means that the business will only report its income on the single owner’s tax return.
Single Member LLC Disregarded Entities
Single-member limited liability companies (SMLLC) have a single owner. The single owner can be either a person, a corporation, or another LLC.
SMLLCs are the most common disregarded entities in the United States. These kinds of LLCs are classified by default as disregarded entities by the IRS unless the company chooses a different classification. You can notify the IRS that you would like to be classified differently (if you qualify) by sending in Form 8832.
In addition to SMLLCs, qualified REIT (real estate investment trust) subsidiaries and qualified subchapter S subsidiaries can be classified as disregarded entities.
What are the Tax Purposes of a Disregarded Entity LLC?
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Typical corporations face double taxation, first when they pay taxes on their profits and again when the remaining income is taxed again at the owner’s level.
SMLLCs avoid this double taxation thanks to its “disregarded” status. Instead, they face something called pass-through taxation.
Pass-Through Taxation
Pass-through taxation means that all business earnings, losses, expenses, and credits skip the company level and pass straight through to the owner’s level. All income is reported on the owner’s personal tax return.
The other advantage of this form of taxation is its simplicity because the company does not have to file its own tax return. Only the owner’s return must be filed to the IRS.
How the Limited Liability Protection Works
Like corporations, LLCs benefit from limited liability protection. In a lawsuit against an LLC, the owner’s personal assets will not be at risk of seizure.
This is not the case for sole proprietorships. Sole proprietors can lose their personal assets if judges and courts make decisions against the business.
In this sense, SMLLCs benefit from the best of both worlds. Despite being disregarded by the IRS, SMLLCs maintain their limited liability like multi-member LLCs and corporations. And unlike corporations, SMLLCs can claim “disregarded entity” status to avoid double taxation.
Losing Disregarded Entity Status
SMLLCs can lose their disregarded entity status if they bring on an additional owner, or if the owner fails to prove that business assets and personal assets are placed in separate accounts. Failing to use a business bank account, for example, can put owners at risk. It is important to consult a licensed lawyer or accountant for information about your specific case.
Do I Need an EIN for my LLC?
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An SMLLC that has no employees and no excise tax liability does not need an employer identification number (EIN). The owner only needs to provide his or her SSN or tax identification number (TIN) for federal taxes. If the SMLLC would like an EIN, the owner can always apply to the IRS for one.
If the SMLLC has employees or is liable to pay excise taxes, then the EIN of the LLC must be used for federal tax purposes. An LLC can apply for an EIN by sending in Form SS-4, Application for Employer Identification Number.
Learn exactly what you need to open a business bank account for an LLC in the United States with our dedicated guide. You will see that you need an EIN to open a business bank account.
Frequently Asked Questions About Disregarded Entity LLCs
Other Guides About Business Banking In the United States
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