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A Disregarded Entity refers to a business entity that is separate from the owner for liability purposes but is not separate for federal tax purposes. The IRS classifies a single-member LLC by default as a disregarded entity and treats the business as a sole proprietorship for income tax purposes. By being recognized as disregarded, the company’s income, expenses, losses, gains, deductions and credits are reported on the owner’s income tax return.

If the LLC owner is an individual, he would report income and expenses on Schedule C, Profit and Loss for Business; or Schedule E, Supplemental Profit and Loss; or Schedule F, Profit or Loss from Farming. The owner, however, can also be a business owner, including another LLC.

Why use a disregarded entity?

Having an LLC be a disregarded entity makes year end taxes less complex since there isn’t a separate entity tax filing.    Additionally, the owner of an LLC taxed as a corporation must report and pay unemployment insurance on themselves.

Taxpayer Identification Number

When filing for income tax, the owner of a single-member LLC that is treated as a disregarded entity will typically use the owner’s Social Security number on all returns and forms related to income tax, unless the LLC has employees.

LLC’s With Employees

If a single-member LLC has employees, the IRS treats the company as a separate entity when it comes to employment tax and certain excise taxes. Since 2009, a single-member LLC must use its name and Employer Identification Number to report and pay employment taxes. Though the IRS does not require an LLC to have an EIN unless it has employees or pays excise tax, the company may still need an EIN to open a bank account or meet state regulations.  An LLC owner can apply for an EIN online at the IRS website. The online application is free, and the LLC receives the EIN immediately.

Changing Tax Status

There are two ways for an LLC to be taxed as a corporation.

Liability Protection Unaffected

Regardless of how an LLC is taxed, the liability protection offered by an LLC is unchanged. The LLC protects the owner’s personal assets from the debts and obligations of the company as long as the owner maintains an account of business income and expenses separate from personal accounts. Any personal assets used as collateral for business loans are not protected.

A single-member LLC can elect to change its tax classification to be treated as a corporation, even if the actual business structure remains the same. The addition of another member for the LLC will also result in changing the tax treatment from sole proprietorship to partnership. Tax repercussions from changing the tax status can be complicated, depending on the company’s specific situation, making the advice of an accountant highly valuable.

When it is better for an LLC to be taxed as a corporation?

For most people, being taxed as a corporation doesn’t make sense until it is making a decent profit.  The owner of a Limited Liability Company taxed as a corporation becomes an employee of the business in addition to being an owner.  When this happens, the sole owner has to submit quarterly payroll taxes and pay unemployment insurance on themselves.  The benefit of being taxed as a corporation is that after the owner takes a “reasonable salary”, any additional profits can be distributed as dividends.  As a disregarded entity, those profits would have been subject to self-employment taxes of 15.3%.  A reasonable salary varies by the type of work being performed and the amount of time the owner spends working in the business. 

Remember that everyone’s personal situation and business needs will be different, so be sure to talk with a professional before making a decision!