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What is a Disregarded Entity?
A disregarded business entity is legally different from the owner, but it does not have a tax exemption. In the U.S. context, a disregarded entity is not required to file a tax return.
Key Points of Disregarded Entity:
Single-Member LLC:
A single-member LLC is the most common disregarded entity. Tax-wise, the IRS does not consider the LLC to be separate from its owner. Therefore, business expenses and income are reported in the owner’s return on Schedule C.
Tax Treatment:
The entity does not pay tax at the entity level because it is disregarded. Owners pay taxes directly on business income.
Liability Protection:
A disregarded entity is treated as if it were nonexistent, but the owner’s liability is protected, as is the owner’s assets from business liability.
Other Examples:
Various grantor trusts qualify for subchapter-S subsidies (QSubs), and LLCS with a single member are treated as disregarded entities.
A disregarded entity is an important tax designation that allows business owners to simplify tax reporting while maintaining the legal protection of their assets.
Disregarded Entity Examples
Here are some common examples of disregarded entities:
Single-Member LLC (Limited Liability Company):
- Example: John Doe creates a one-member LLC named “Doe Consulting LLC.” Tax-wise, the LLC is disregarded, so John must report all of its income and expenses in his tax return, Form 1040, typically on Schedule C, Profit or Loss From Business.
- Benefits: John benefits from the protection provided by an LLC without having to file separate tax returns for his business.
Qualified Subchapter S Subsidiary (QSub):
- Example: XYZ Corporation is an S corporation that owns 100% of a subsidiary called XYZ Sub Inc. XYZ elects XYZ Sub Inc. to be treated as a QSub and disregarded entity. Tax-wise, XYZ Sub Inc.’s assets, liabilities, and income are the same as XYZ Corporation.
- Benefits: XYZ Corporation can simplify tax reporting by including the QSub activities in its own S corporation tax returns.
Grantor Trust:
- Jane creates a revocable ‘trust’ and names herself both as grantor and trustee. This trust is disregarded for tax purposes. Jane reports all income on her tax return.
- Benefits: Although the trust assets are managed independently, the tax treatment is the same as it would be if Jane had owned them directly.
Single-Member Foreign LLC (for U.S. Tax Purposes):
- Emily, an American citizen, owns a single-member LLC in a foreign nation. The U.S. could treat this foreign LLC as a disregarded foreign entity. Emily would then report her foreign income to the U.S.
- Benefits: Emily adheres to U.S. taxes as a disregarded company while maintaining the legal and operating structure required by foreign jurisdictions.
These examples show how disregarded entities simplify tax reporting while providing legal and operational advantages to business owners.
Also See: Employee Identification Number (EIN) | Shift Differential Pay
