One of the first considerations you need to make when starting your own business is choosing the type of business entity that best fits your needs. You’re likely familiar with the LLC, corporation, and partnership structures, but there’s another option you may not have heard of — the disregarded entity.
What you’ll learn
What you’ll learn
Key takeaways
- Single-member LLCs automatically become disregarded entities unless you elect to be taxed as corporation with the IRSe
- Self-employment taxes apply to 100% of a single-member LLC’s business profits
- Hiring employees requires an EIN and full compliance with standard payroll tax requirements and quarterly filings
- State tax obligations often differ from federal regulations, with some states imposing separate LLC fees or taxes
If you operate a single-owner business, particularly a single-member limited liability company (SMLLC), pursuing disregarded entity status can be a way to simplify your tax filings and potentially lessen your tax obligations. Essentially, a disregarded entity is a type of business that the IRS chooses to “disregard” as a separate entity from its owner for federal income tax purposes.
In other words, income and expenses related to the business are reported directly on the owner’s personal tax return, rather than on a separate business tax return. Many small businesses opt for disregarded entity status, because it eliminates the need to pay taxes twice on the same income.
Understanding disregarded entities: Ownership structure and IRS classification
Fundamentally, a disregarded entity is a business that has one owner and isn’t already structured as a corporation. For federal income tax purposes, the IRS treats the company and its owner as the same taxable “entity,” just like a sole proprietorship.
Incidentally, when a business forms as a single-member LLCs, it automatically receives the disregarded entity status for tax purposes, unless the business owner pursues alternative tax classification treatment.
How do I know if my business is a disregarded entity?
“If you’ve established a single-member LLC, but have not filed Form 8832 with the IRS to elect corporation status for taxation, then your business is automatically a disregarded entity.”
— Tom Brock, CFA, CPA
Disregarded entities vs. partnerships, corporations, and multi-member LLCs: What sets them apart
Corporations, whether C Corps or S Corps, are always considered separate entities for tax purposes, and multi-member LLCs are considered partnerships. This means the members of a multi-member LLC are required to file an informational return for their business using Form 1065, while also reporting income and losses on their individual returns.
Filing taxes as a disregarded entity is a much simpler endeavor than filing taxes for any of the aforementioned business structures. To reiterate, a disregarded entity is a business with only one owner who reports income directly on his or her personal tax return. Moreover, by default, a single-member LLC is taxed as a disregarded entity.
There’s a lot of terminology involved. To make the differences clearer, here’s a side-by-side comparison of how disregarded entities stack up against other business structures.
| Entity type | Number of owners | Federal income tax treatment | Separate business tax return required? | Double taxation? |
| Disregarded entity (SMLLC) | One | Income reported on owner’s Form 1040 (Schedule C) | No | No |
| Multi-member LLC | Two or more | Treated as partnership | Yes (Form 1065) | No |
| S Corporation | One or more | Pass-through taxation | Yes (1120-S) | No |
| C Corporation | One or more | Entity-level taxation | Yes (1120) | Yes |
Federal tax treatment and pass-through taxation
The biggest difference between a disregarded entity and other kinds of entities relates to taxation. With a disregarded entity, the IRS treats business income and expenses as if they directly pertain to the business owner. This means you report all business revenue and any deductible expenses on your personal tax return, generally on Schedule C of Form 1040.
This treatment, which is standard for sole proprietorships and single-member LLCs, is known as “pass-through taxation.” Because the business doesn’t pay federal income tax directly, its profits and losses pass through to the individual owner, and he or she is taxed based on applicable personal income tax rates. Administratively, it’s a relatively simple tax filing process, and it ensures avoidance of the double taxation burden that C-corps face.
What is a disregarded entity for tax purposes?
“A disregarded entity is a business that is distinct from its owner for legal purposes, but ignored for federal income tax purposes. Generally, this classification pertains to a single-member LLC, which has not opted to be taxed as a corporation. With a disregarded entity, income and expenses are reported on the owner’s individual tax return.”
— Tom Brock, CFA, CPA
Self-employment tax obligations
One of the most persistent myths about business entities pertains to disregarded entities and the self-employment tax. Even though you only pay income taxes once on the income from your disregarded entity business (via your personal income tax return), you’re still liable for self-employment tax. These taxes cover Social Security and Medicare obligations that are shared by an employer and employee in a traditional employment arrangement. However, as a self-employed individual, you’re responsible for both the employer and employee shares of the tax.
Long story short, when projecting your tax obligations, be sure to consider the self-employment tax, in addition to income tax.
Moving on, let’s expand our perspective and consider how state taxes come into play for disregarded entities.
Is a single-member LLC a disregarded entity?
A business established as a single-member LLC is automatically classified as a disregarded entity, unless the business owner files Form 8832 with the IRS and elects to have the business taxed as a corporation.
When does a disregarded entity need an EIN?
Although a disregarded entity isn’t considered a separate entity for federal income tax purposes, you’ll need to get an Employer Identification Number (EIN) if you start to bring on team members. The IRS requires an EIN to file payroll taxes. You’ll also need to get an EIN if you ever opt to have your business taxed as a corporation.
Key payroll and compliance rules for employers operating disregarded entities
Disregarded entities are subject to the same payroll and compliance rules imposed on other types of business entities. Disregarded entities that have employees must obtain an EIN, and they are responsible for withholding and remitting payroll taxes, including Social Security, Medicare, and other taxes, from employees’ wages.
Moreover, if you operate as a disregarded entity, you must file quarterly payroll tax returns via Form 941 and unemployment tax returns via Form 940. Additionally, you must issue W-2 forms to every employee and comply with all federal and state labor laws, including regulations on minimum wage, overtime, and unemployment insurance.
This can be a lot to track, especially for a single-owner business bringing on its first employees. Here’s a simplified overview of the primary payroll and compliance requirements.
| Requirement | What it involves | When it applies |
| EIN | Obtain Employer Identification Number | Required when hiring employees or electing corporate taxation |
| Payroll tax withholding | Withhold Social Security, Medicare, and income taxes | When paying W-2 employees |
| Form 941 | Quarterly federal payroll tax return | Every quarter with employees |
| Form 940 | Federal unemployment tax return | Annually |
| W-2 forms | Issue wage statements to employees | Annually |
| Labor law compliance | Minimum wage, overtime, unemployment insurance | Ongoing |
Advantages of being a disregarded entity
The primary benefit of running a business as a disregarded entity is simplification of the tax filing process . Because business income and expenses are reported on the owner’s personal tax return, there’s no need for a separate corporate tax return. Unlike corporations, disregarded entities aren’t responsible for annual meetings, detailed minutes, and extensive record-keeping. Moreover, the income generated by a disregarded entity is not subject to double taxation.
That said, it’s important to note that a disregarded entity is still an LLC, meaning it provides liability protection that protects the owner’s personal assets from any business liabilities, including lawsuits. Sole proprietorships don’t have this advantage.
What owners should know: Common pitfalls and strategic considerations
The advantages of maintaining a disregarded entity are clear, but running this type of business can have some downsides.First of all, disregarded entities typically pay higher Social Security and Medicare taxes than other types of businesses. As your single-owner LLC grows, it’s important to determine the most effective way to pay yourself as the business owner. At some point, it could make sense to elect to be taxed as an S Corp to maximize after-tax income.
A second drawback of disregarded entities pertains to investment capital. Many lenders and investors are reluctant to provide financing to single-member LLCs, because they view these types of entities as unsophisticated. They prefer the higher degree of governance associated with corporations and partnerships. This can make fundraising difficult for a disregarded entity.
Good to know
If you maintain a disregarded entity, it’s vitally important to keep your personal and business finances separate. Any commingling of funds can invalidate the liability protection provided by a single-member LLC.
Choosing a disregarded entity can save double duty
A disregarded entity gives single-owner businesses a straightforward path to simplify their tax filings and avoid the double taxation burden of C-corps. The administrative and financial benefits are clear, but running a disregarded entity will not eliminate your self-employment tax, state income tax, and payroll compliance obligations (in the event you bring on employees). As a result, whether you’re launching a new venture or rethinking your current business structure, partnering with a reliable online payroll provider can help you optimize your operation.
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Tom Brock, CFA, CPA is an accomplished financial professional, with over 20 years of experience in investments, corporate finance, and accounting. His investment experience includes oversight of a $4 billion portfolio for an insurance group. Varied finance and accounting work includes the preparation of financial statements and budgets, the development of multiyear financial forecasts, credit analyses, and the evaluation of capital budgeting proposals.