How Is a Regarded Entity Taxed by the IRS?

A regarded entity is a business that the Internal Revenue Service (IRS) recognizes as a distinct and separate taxpayer from its owners. This designation is purely for tax purposes and dictates that the business itself is responsible for filing its own income tax return. A business is formed under state law, which defines its legal status and liability protection, while the federal tax classification determines how the business reports its income and pays taxes to the IRS.

Types of Regarded Entities

Certain business structures are automatically considered regarded entities by the IRS. A traditional corporation, established by filing articles of incorporation with a state, is the most common example. By default, the IRS views a corporation as a separate taxable entity responsible for its own tax obligations.

Unincorporated businesses with two or more owners, known as partnerships, are also treated as regarded entities for tax reporting purposes. While the partnership itself does not pay income tax, it is required to file an annual information return, Form 1065, U.S. Return of Partnership Income, to report its income, deductions, gains, and losses. The tax liability then flows through to the individual partners.

A Limited Liability Company (LLC) has flexibility in how it is treated for federal tax purposes. While a single-member LLC is by default a “disregarded entity” and a multi-member LLC is a partnership, either can elect to be taxed as a regarded entity. This choice allows LLC owners to select the tax treatment of a corporation if it better suits their financial goals, without changing their underlying legal structure.

Corporate Tax Classifications

When a business is treated as a regarded entity, it is taxed as a corporation. There are two primary corporate tax classifications: C Corporation and S Corporation. The default classification for a corporation is a C Corporation. Under this structure, the corporation’s profits are taxed at the corporate level, and it files Form 1120, U.S. Corporation Income Tax Return, to report its income and calculate its tax.

If the corporation then distributes its after-tax profits to its shareholders in the form of dividends, those shareholders must pay personal income tax on that dividend income. This creates a situation often referred to as “double taxation,” where the same pool of profit is taxed once at the corporate level and again at the individual shareholder level.

Alternatively, an eligible entity can elect to be treated as an S Corporation. This election changes the tax treatment to a “pass-through” system. In an S Corporation, the business’s profits, losses, deductions, and credits are passed directly to the shareholders, who then report them on their personal tax returns and pay tax at their individual income tax rates. This structure avoids the double taxation associated with C Corporations.

Making the Tax Classification Election

For an eligible business, such as an LLC, to change its default tax status and be taxed as a corporation, it must file Form 8832, Entity Classification Election, with the IRS. The form requires basic information about the business, including its name, address, and Employer Identification Number (EIN), along with the specific election being made and the date it is to take effect.

Once an entity has elected to be taxed as a corporation using Form 8832, or if it is a corporation by default, it can further elect to be treated as an S Corporation. This subsequent election is made by filing Form 2553, Election by a Small Business Corporation. To be eligible, the corporation must meet certain requirements, such as having no more than 100 shareholders and only one class of stock.

A component of both Form 8832 and Form 2553 is obtaining the consent of the owners. The forms require the signature of each shareholder or member, or an officer authorized to sign on behalf of the entity, signifying their agreement to the tax classification change.