What is the IRS Definition of a Disregarded Entity?

A disregarded entity is a business structure that is legally separate from its owner for liability purposes but is not treated as a separate entity for federal income tax purposes. The Internal Revenue Service (IRS) ignores the business’s existence for income taxes, treating its financial activities as a direct extension of the owner. This structure provides the owner with limited liability, shielding personal assets from business debts, while simplifying tax reporting.

The profits and losses of the business “pass through” to the owner and are reported on their personal tax return. This approach avoids the double taxation that can occur with other corporate structures. The term “disregarded entity” is a tax classification and does not alter the legal standing of the business under state law.

Entities Classified as Disregarded

The most common business structure classified as a disregarded entity by default is the single-member limited liability company (SMLLC). When an individual is the sole owner of an LLC, the IRS automatically treats it as a disregarded entity for income tax purposes unless the owner elects for it to be taxed differently. The business’s activities are treated as if they were conducted by a sole proprietorship for federal income tax reporting.

A Qualified Subchapter S Subsidiary (QSub) is another example of a disregarded entity. A QSub is a corporation that is 100% owned by a parent S corporation, which must file Form 8869, Qualified Subchapter S Subsidiary Election. Once the election is effective, the QSub is not treated as a separate corporation for federal tax purposes, and its assets, liabilities, and items of income are all treated as belonging to the parent S corporation.

Certain types of trusts can also be considered disregarded entities. A grantor trust, where the individual who created the trust (the grantor) retains control over its property, can be treated as a disregarded entity. The IRS views the grantor as the owner of the trust’s assets for tax purposes, and all income and expenses of the trust are reported on the grantor’s personal income tax return.

Federal Tax Reporting Requirements

The financial activities of a disregarded entity are reported directly on the owner’s personal tax return. All of the entity’s income, deductions, gains, and losses are passed through to the owner and included on their Form 1040, U.S. Individual Income Tax Return.

The specific schedule used on the owner’s Form 1040 depends on the nature of the business activity. If the entity operates an active trade or business, the owner will report its income and expenses on Schedule C, Profit or Loss from Business. For activities involving rental real estate, the owner would use Schedule E, Supplemental Income and Loss, while farming activities are reported on Schedule F, Profit or Loss from Farming.

An exception to the pass-through nature of a disregarded entity relates to federal employment and excise taxes. For payroll taxes (Social Security, Medicare, and federal unemployment) and certain excise taxes, the IRS treats the disregarded entity as a separate corporation. The entity must obtain its own Employer Identification Number (EIN) to report and pay these taxes for its employees.

This separate treatment requires the entity to file payroll tax returns, such as Form 941 and Form 940, under its own name and EIN. The individual owner of an SMLLC is not considered an employee and remains subject to self-employment taxes on the business’s net earnings.

Completing Form W-9

When completing a Form W-9, Request for Taxpayer Identification Number and Certification, a single-member LLC that is a disregarded entity should enter the owner’s name on Line 1. The LLC’s business name is entered on Line 2, “Business name/disregarded entity name, if different from above.”

For the Taxpayer Identification Number (TIN), the owner must use their own Social Security Number (SSN) or personal EIN. The LLC’s separate EIN used for employment or excise taxes should not be used on Form W-9 for income tax reporting. The box for “Individual/sole proprietor or single-member LLC” should be checked in the tax classification section.

Electing an Alternative Tax Classification

A single-member LLC owner can choose a different tax status through the “check-the-box” regulations, which allow eligible entities to elect their federal tax classification. This can be beneficial if being taxed as a corporation is more advantageous due to factors like corporate tax rates being lower than individual rates.

To change its classification, the entity must file Form 8832, Entity Classification Election, to be taxed as a corporation. The owner specifies the desired classification and its effective date, which generally cannot be more than 75 days prior to filing or more than 12 months after.

If the owner wants the entity to be taxed as an S corporation, it must file Form 2553, Election by a Small Business Corporation. An eligible entity can often file Form 2553 directly without first filing Form 8832. This election must be made by all of the corporation’s shareholders.

To be effective for the current tax year, Form 2553 must generally be filed no later than two months and 15 days after the beginning of that tax year. For a business using the calendar year, the deadline is March 15. If the deadline is missed, the election will not take effect until the following tax year, though relief for a late filing may be available with reasonable cause.