What Is an Entity Disregarded as Separate From Its Owner?

A disregarded entity is a business structure with a single owner that the Internal Revenue Service (IRS) does not recognize as separate for income tax purposes. The IRS ignores the business’s legal formation and treats its financial activities as belonging directly to the owner, creating a pass-through system where profits and losses are reported on the owner’s personal tax returns.

This tax treatment means a separate income tax return for the business is not required, as all income and deductions flow to the owner’s return. This approach avoids the “double taxation” that can occur with corporate structures, where the business pays tax on its profits and the owner is taxed again on distributions. The entity’s legal status under state law, which provides liability protection, remains distinct from this federal tax classification.

Qualifying Business Structures

The most common business structure that qualifies as a disregarded entity is the single-member limited liability company (SMLLC). An LLC is a business entity created under state law that offers liability protection to its owner. When an LLC has only one member, the IRS automatically classifies it as a disregarded entity for federal income tax purposes unless the owner elects for it to be treated as a corporation.

Another example of a disregarded entity is a Qualified Subchapter S Subsidiary (QSub). This is a corporation wholly owned by an S corporation, and the parent S corporation has elected to treat the subsidiary as a disregarded entity. In this arrangement, all assets, liabilities, and items of income and deduction of the QSub are treated as belonging to the parent S corporation.

Business structures with multiple owners, such as a partnership or a multi-member LLC, are not considered disregarded entities. The IRS classifies a domestic LLC with two or more members as a partnership for federal income tax purposes, which requires filing a separate partnership tax return.

Federal Income Tax Reporting

Because of its pass-through taxation, a disregarded entity does not file its own income tax return. Instead, all of its financial activities are reported on the owner’s personal income tax return, such as Form 1040 or 1040-SR. This consolidates business and personal tax reporting into a single filing.

The specific schedule used on the Form 1040 depends on the nature of the business’s operations. If the owner is an individual and the entity is engaged in an active trade or business, its income and expenses are detailed on Schedule C, Profit or Loss from Business. For activities involving rental real estate, the financial results are reported on Schedule E, Supplemental Income and Loss. Similarly, farming activities would be reported on Schedule F, Profit or Loss from Farming.

For federal income tax purposes, the disregarded entity uses the owner’s taxpayer identification number. If the owner is an individual, this will be their Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN). The owner’s name and SSN or ITIN are used on the relevant schedules. A separate Employer Identification Number (EIN) is not needed for income tax reporting unless the entity has employees or an excise tax liability.

Exceptions to Disregarded Status

While an entity is disregarded for income tax purposes, it is not disregarded for all federal tax matters. The IRS treats the entity as a separate business for federal employment tax purposes. If the disregarded entity has employees, it is responsible for all employment taxes, including Social Security, Medicare (FICA), and federal unemployment (FUTA) taxes.

To manage these obligations, the disregarded entity must obtain its own Employer Identification Number (EIN). This EIN must be used for reporting and paying all employment taxes. The business is required to file quarterly employment tax returns, such as Form 941, Employer’s QUARTERLY Federal Tax Return, and an annual return, Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, under its own name and EIN. The owner cannot use their personal Social Security Number for these filings.

The entity is also treated as separate for certain federal excise taxes. If the business is involved in activities that require the payment of excise taxes, such as those related to fuel or manufacturing, it must register using its own name and EIN. The entity is then responsible for filing forms like Form 720, Quarterly Federal Excise Tax Return, and remitting the taxes under its own EIN.

Changing the Default Tax Status

An owner of a disregarded entity can change its default tax classification. An eligible entity, such as a single-member LLC, can elect to be taxed as either a C corporation or an S corporation. This change requires the owner to file a specific form with the IRS to make a formal election.

The election is made by filing Form 8832, Entity Classification Election. The entity must have an Employer Identification Number (EIN) to file this election, even if it does not have employees. When completing Form 8832, the owner must provide the entity’s legal name, EIN, and address.

The form requires the owner to specify the tax classification being elected and the date the election will become effective. An election can take effect no more than 75 days prior to the date the election is filed and no more than 12 months after the date of filing. The completed Form 8832 must be signed by the owner.