Written by: Steven J. Fromm, J.D., LL.M. (Taxation)
A disregarded entity refers to a business entity with one owner that is not recognized for tax purposes as an entity separate from its owner.
A single-member LLC ( "SMLLC"), for example, is considered to be a disregarded entity. For federal and state tax purposes, the sole member of a SMLLC disregards the separate legal status of the SMLLC otherwise in force under state law.
As the result of being “disregarded,” the SMLLC does not file a separate tax return. Rather, its income and loss is reported on the tax return filed by the single member:
- If the sole owner is an individual, the SMLLC's income and loss is reported on his or her Form 1040, U.S. Individual Income Tax Return and through filing a Schedule C, E or F in most cases. This tax reporting method is similar to a sole proprietorship reporting his or her income on such schedules.
- If the owner is a corporation, the SMLLC's income or loss is reported on the corporation's Form 1120, U.S. Corporation Income Tax Return (or on Form 1120S in the case of an S Corporation). This treatment is similar to that applied to a corporate branch or division which is normally reported on the Form 1120 or 1120s.
A SMLLC is not the only entity treated as a disregarded entity. Two corporate forms are also disregarded:
- A qualified sub-chapter S subsidiary
- A qualified REIT subsidiary.
However, SMLLCs are by far the most common disregarded entity currently in use.
So, basically for federal tax purposes, the SMLLC does not exist. All its assets and liabilities are treated as owned by the acquiring corporation.
Even though a disregarded entity’s tax status is transparent for federal tax purposes, it is not transparent for state law purposes. Remember, an LLC is a corporation under state law and its shareholders enjoy certain legal protections. For example, an owner of an SMLLC is not personally liable for the debts and obligations of the entity. However, since the entity is disregarded, the owner is generally treated as the employer of disregarded entity employees for employment tax purposes.
Finally, keep in mind that some states, like Pennsylvania, require that state tax returns be filed for these disregarded entities.
For further details on disregarded entities or how this tax strategy may fit into your business operations, please contact our offices.
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