What Is a Disregarded Entity?

If you own a single-member LLC you might have seen the term “disregarded entity” on IRS forms or tax websites. It simply means the IRS does not see your company as separate from you for federal income tax purposes. This article explains in plain language how disregarded entities work, how income and employment taxes are handled, and when you may want to change the tax status of your LLC.

What is a Disregarded Entity?

If you have formed a single-member LLC, you might be surprised to learn that the IRS does not see it as separate from you for income tax purposes. The IRS calls this a disregarded entity.

In other words, while the LLC exists legally and protects you from business liabilities, it is “disregarded” when it comes to federal income taxes. You report the income and expenses of your LLC directly on your personal tax return. Here is a quick overview:

How Does a Disregarded Entity Pay Taxes?

For income tax, the answer is simple. The LLC itself does not file a separate return. You just include everything on your personal return. But here is the important part many new entrepreneurs miss: for employment taxes and excise taxes, the LLC is treated as separate. This means:

• If you have employees, the LLC must file payroll tax forms and withhold taxes using its own Employer Identification Number (EIN).
• If your business activities involve excise taxes, the LLC must file those returns as well.

So “disregarded” generally applies only to federal income tax. However, depending on the state where your LLC is registered or operates, you may be required to pay state-imposed taxes or fees, even if the LLC is disregarded for federal income tax purposes.

Advantages and Disadvantages of a Disregarded Entity

Depending on your goals, the disregarded entity structure can work to your benefit or create challenges. Here is a clear overview:

Can You Change the Status of a Disregarded Entity?

Yes. By default, a single-member LLC is a disregarded entity. But you can file Form 8832 with the IRS to elect corporate taxation. If you qualify, you can also file Form 2553 to be treated as an S corporation.

These elections can sometimes save money, especially if you are paying a lot in self-employment taxes. However, they also make your taxes more complex and may require payroll for yourself as an owner.

Illustrative Example

Lisa launches an online retail business and decides to structure it as a single-member LLC. Under federal tax rules, her LLC is treated as a disregarded entity. For tax purposes, all business revenues and expenses are reported directly on her personal Form 1040, via Schedule C. The net profit is subject to both income tax and self-employment tax (covering Social Security and Medicare).

Once Lisa begins hiring staff, the LLC must operate under its own EIN to manage payroll reporting and tax withholdings. As the business expands, she has the option to elect S corporation status, which can change the way her income is taxed and potentially reduce the overall burden.

Key Takeaways

• A disregarded entity is usually a single-member LLC.
• For federal income tax, the IRS ignores the entity and you file on your personal return.
• For employment and excise taxes, the LLC is separate and must use its own EIN.
• You keep liability protection while enjoying simpler tax filing.
• You can change the tax status later if your business needs evolve.