A disregarded entity is a business that’s not separate from its owner for federal tax purposes—the owner reports and pays the business portion of income and taxes on their tax return. This information is often reported on Schedule C, but you may also find it on Schedule E or Schedule F.
Key Takeaways
- A disregarded entity is a business that the IRS taxes by including its income and expenses directly on the owner’s tax return.
- The most common disregarded entity is a single-member limited liability company (LLC) that does not make an election to be taxed as a corporation. Learn more about LLCs.
- A disregarded entity owned by an individual is subject to self-employment tax on ordinary business income.
- A disregarded entity may have state-level filing requirements.
Filing Requirements of Disregarded Entities
Filing requirements for disregarded entities may vary depending on the specific state and entity type. In general, you should expect to file the following:
- Federal taxes: For federal income tax purposes, a disregarded entity owned by an individual will report income and expenses on its owner’s personal income tax return, Form 1040 Schedule C.
- State and local taxes: Depending on where you operate your disregarded entity, you may also be required to file state and local income taxes. The tax forms you must file vary by locality but, generally, you can find out by navigating your state’s comptroller’s website.
- Payroll taxes: If your disregarded entity has employees, you may also be required to pay payroll taxes and file IRS Form 941. However, disregarded entities cannot treat their owner as an employee.
- Form 1099 NEC: If you hire contractors, you may also be required to file IRS Form 1099 NEC.
Less Common Types of Disregarded Entities
While the most common type of disregarded entity is a single-member LLC, a few other less common types of entities can also be treated as disregarded entities under certain circumstances. Here are some examples:
- Qualified subchapter S subsidiary (QSub): A QSub is an S corporation (S-corp) that is owned by another S-corp. A QSub is a disregarded entity for federal tax purposes and treated as a branch of the S company that owns it. The best part is that the federal and state governments only need a tax return from the parent S-corp.
- Grantor trust (living trust): A grantor trust—also called a revocable trust—is a type where the grantor retains control over the trust assets and is considered the owner for income tax purposes. The trust does not file a separate return, and the grantor trust’s income, expenses, and credits are reported directly on the grantor’s return.
Disregarded entity vs single-member LLC: While there is a lot of overlap, not all single-member LLCs are disregarded entities and not all disregarded entities are single-member LLCs. Some single-member LLCs elect to be treated as C corporations (C-corps) or S-corps for tax purposes and therefore are no longer disregarded.
Pros & Cons of a Disregarded Entity
| Advantages | Disadvantages |
|---|---|
| Less paperwork because the entity does not have to file a separate federal tax return | Income subject to self-employment tax |
| May offer limited liability protection | Loans and leases between the disregarded entity and owner are not recognized for tax purposes |
| Not disregarded for sales and use, franchise, and excise tax purposes | |
How To Form a Disregarded Entity
- Choose an entity type: The first step is to choose the entity type. The most common type is a single-member LLC. Other entities, such as certain types of trusts or qualified subchapter S subsidiaries, may also be eligible for disregarded entity status in specific circumstances.
- Pick a state: Select where you want to establish your disregarded entity. LLC laws and requirements vary by state, so it’s essential to consider factors like taxation, regulations, and operating flexibility when choosing a state.
- Select a name: Select a unique name for your entity that complies with your state’s naming requirements. The name should not conflict with existing business names in the state. Our tips for naming your business may be of interest to you; we also include a business name generator to help you get started.
- File the articles of organization: Prepare and file all the documents your state requires. If you are creating an LLC, you must file the articles of organization. The articles of organization are official documents required to establish an LLC at the state level. They contain important information about the LLC, such as its name, purpose, registered agent, and management structure.
- Determine if you need an employer identification number (EIN): An EIN is a unique nine-digit identification number issued by the IRS. Read our guide on how to get an EIN if you require assistance.
- Comply with state requirements: Be aware of any state or local compliance requirements. Depending on which state the business is organized in, you may have to file an annual report and pay franchise taxes.
Frequently Asked Questions (FAQs)
Sometimes. A single-member LLC is classified automatically as a disregarded entity by the IRS, but it can elect to be treated as a corporation instead. Multimember LLCs are never disregarded entities.
No. Although its income and losses pass through to shareholders, it is not disregarded for federal tax purposes and must file its own tax return on Form 1120S.
Yes, most new disregarded single-member LLCs require an EIN. LLCs apply for EINs using Form SS-4. Form SS-4 explains the EIN application.
No, K-1s will not be issued. Instead, itemized income and expenses are reported directly on the owner’s tax return, usually Schedule C. However, multimember LLCs are not disregarded entities and they should file Form 1065 or Form 1120S and issue K-1s.
Bottom Line
If you want to start a business, using a disregarded entity may be the easiest type of business for you to start. Disregarded entities offer the limited liability of an LLC without requiring a separate income tax return to be filed. The downside is that you’ll have to pay self-employment tax on all the business income.
