The limited liability company (LLC) disregarded entity is a type of business structure that allows the company owners to choose what taxes they want to be responsible for.
It can come with certain tax benefits, but it also has some disadvantages.
A Disregarded Entity LLC is a type of business entity that allows the owner to have pass-through taxation.
This also means that you can take advantage of what is known as "tax deductions," which will help lower your tax liability.
The disregarded entity status is only available to LLCs that have one member.
The IRS disregards an entity with just one owner for income tax purposes.
It is treated as a sole proprietorship or disregarded single-member LLC (if the business has no other employees).
Disregarded Entities and Taxes
A disregarded entity means that the business represents a separate entity from its owners for tax purposes.
There are two disregarded entities: single-member LLCs (only one owner) and multi-member LLCs (LLCs with more than one member).
The default federal income tax classification for a single-member LLC is a disregarded entity treated as a sole proprietorship.
In contrast, the default federal income tax classification for a multi-member LLC is a partnership.
However, an LLC can choose to tax a corporation by filing Form 8832, Entity Classification Election.
Only the owner of a disregarded entity is taxed on the entity's income. The business itself does not pay tax on its income because it flows through to the owner's individual tax return.
This is different from a corporation, which pays tax on its income, and then shareholders are taxed on their dividends.
This treatment can be beneficial for business owners because it saves them from filing a separate tax return for the entity.
Most LLCs are disregarded entities, often the best option for small businesses.
The main benefit of being a disregarded entity is that the owner can avoid double taxation on the business income.
However, if you are in a high tax bracket, you may want to elect corporate taxation for your single-member LLC.
There are also disadvantages of being a disregarded entity that should be considered before choosing.
If an owner holds significant assets in his or her name alone, then electing to file as a corporation can lead to unfavorable tax treatment when the business uses those assets.
Federal Income Taxes
Disregarded entities are treated as separate entities for federal tax purposes.
The owner of an SMLLC is not considered a company employee, so they don't receive a salary. Instead, SMLLC owners extract profits from their LLC capital accounts.
This cash isn't taxed when it's withdrawn, but the owners are responsible for paying any applicable state and federal taxes every four months.
The income taxes are based on the owner's individual tax rate, which could be as high as 37% if they're in the highest tax bracket.
Employment Taxes
Apart from the income taxes, an SMLLC owner must pay self-employment tax on their net earnings from the business.
FICA taxes (Social Security and Medicare) usually fall on the sole owner of the SMLLC if the company has no employees.
The FICA tax is split between the owner and the employees.
This means that you could be paying up to 15.0% in FICA taxes based on your net income from self-employment, which is double what a partner in an LLC partnership would pay (usually only about half of the business' profit).
Excise Taxes
LLCs, pay taxes for the goods and services it provides. This is known as an excise tax. There are a few different excise taxes, but the most common is the sales tax.
Some LLCs need to pay excise taxes because they provide goods and services that are subject to them.
For example, an LLC that makes and sells cigarettes would need to pay a tobacco excise tax.
Or, an LLC that provides a service and is subject to certain excise taxes may need to pay them depending on the type of business it conducts.
Excise taxes are calculated based on state and federal laws where your business operates and vary from one location to another.
If you work in multiple states or countries, for example, each will have its laws and rates of taxation.
Excise taxes can be confusing since they vary depending on the type of service or product, so if you are unsure whether your LLC is subject to them, it's best to consult with a tax professional who works in this area.
See More: What Tax Form Does an LLC File
Corporate Taxes
LLC taxes are separate from personal income taxes. Corporate taxes are the taxes businesses pay on their profits.
All companies, including LLCs, can be taxed as corporations (C or S corporations).
For your LLC to be taxed as a C corporation, you should file Form 8832 of the Internal Revenue Code.
In that case, a C corp LLC will be subject to the federal corporate tax rate of 21%. Local and state corporate taxes are also applicable.
On the other hand, filing Form 2553 with the Internal Revenue Service allows you to tax an S corporation.
S corporations are separate business entities from their owners and file their tax returns, which is why S corp LLCs don't pay personal income taxes.
Instead, S corporations need to pay taxes on distributions and salaries paid to their owners.
If your LLC doesn't choose any corporate tax options mentioned above, it will automatically be taxed as a sole proprietorship.
The Benefits of LLC Disregarded Entity
The Internal Revenue Service has provided a limited liability company structure for business owners to form LLCs.
The difference between an LLC business type and others is that the Internal Revenue Service (IRS) treats it as its tax entity rather than requiring taxation through its owners or members.
This translates to simpler tax filing. If you're planning to operate your LLC in a certain way, the choice can be crucial for both personal and business reasons.
Disregarded entities offer limited liability protection and tax benefits for business owners.
The biggest advantage of an LLC disregarded entity is that it allows companies to avoid double taxation and protects the owner's assets.
This happens when profits are taxed at both the corporate and shareholder levels. Profits from a disregarded entity flow through to the owner's tax return, avoiding this issue.
The limited liability protection ensures that the company's owners are not held liable for any debts or legal judgments the company may incur.
This is a crucial benefit since it can help protect personal assets in litigation.
When deciding if an LLC disregarded entity is right for your business, some important factors to consider.
First, you need to understand how the business income will be treated at the federal and state levels.
You also need to ensure that you meet all of any LLC's formal legal requirements, such as having a written operating agreement in place.
The Downsides of LLC Disregarded Entity
Many small business owners usually opt for a single-member limited liability company, but they overlook two major downsides.
In practice, it is much more difficult for a single-member LLC to maintain limited liability protection because it is "disregarded" for tax purposes.
First, any income or loss of the LLC flows through to you as an individual taxpayer who must report it on your return.
This means that if there are no other entities involved in the entity structure, your corporate veil is more prone to be pierced in the event of a lawsuit.
The formalities and paperwork required for single-member LLCs might seem overwhelming, but it is less expensive than the alternatives, and at least you have limited liability.
The problem is even more significant if you plan to hire employees as an SMLLC.
That implies that you will be responsible for paying employment taxes, workers' compensation premiums, and other benefits.
Applying for an Employer Identification Number (taxpayer identification number) is also mandatory even if you are an SMLLC but have employees or plan to apply for business loans and open a bank account.
FAQs
What Qualifies as a Disregarded Entity?
A disregarded entity is a separate business entity that is ignored for income tax purposes.
This means that the entity does not file a separate return, and its income passes through to the owner's tax return.
Several disregarded entities, including single-member LLCs, are not organized as corporations.
Does a Disregarded Entity Get 1099?
It depends. A disregarded entity is the same as a sole proprietorship, meaning that it doesn't have an identity of its own, has only one member, and doesn't need 1099.
However, an LLC is not separate from its owner if it's a partnership, so it must get 1099.
Where Do I Report Income From a Disregarded Entity?
The IRS treats single-member LLCs as sole proprietorships for federal tax purposes.
This implies you'll submit IRS Schedule C along with your tax return to report all of the taxable income and expenses from your limited liability company.
Does a Disregarded Entity Have a Tax ID Number?
Unless your LLC needs to pay employment and excise taxes, open a bank account, or apply for business loans, you don't need an employer identification number.
The owner's social security number is enough for federal tax purposes.
Can a Single-Member LLC Be Treated as a Disregarded Entity?
Yes, a single-member LLC can be treated as a disregarded entity for federal income tax purposes. This means that the LLC is not considered a separate entity, and the owner reports business income and expenses on their personal tax return.
What Is a Disregarded Entity LLC...
If you are a business owner, it's important to understand what LLC disregarded entity entails. You may get protection from business debts and other benefits of this type of company structure.
As a business owner, you have to decide what type of entity will be best suited for your needs and consider its pros and cons before making your final decision.
Suppose at any point in time during the life cycle of the business it becomes necessary to dissolve or convert ownership interests in an LLC.
In that case, this should also be done with legal advice to not expose oneself personally liable for any outstanding obligations incurred by said entity.
