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What Is a Disregarded Entity and How Does It Affect Your Taxes?

Disregarded EntityDisregarded Entity
min read
August 21, 2023

If your business structure is a single-member limited liability company (also known as a single-member LLC or SMLLC), the Internal Revenue Service (IRS), by default, categorizes your business as what’s called a “disregarded entity” for tax purposes.

But, as a business owner, you may have questions on what, exactly, that title means—and what it means for you as a taxpayer and for your personal income tax return. What, exactly, is a disregarded entity? How does it impact your tax treatment? And as the owner of a single-member limited liability company, is being taxed as a disregarded entity your only option—or is there a different way you can structure your business for income tax purposes?

What Is a Disregarded Entity?

When you’re running your own business, it makes total sense to structure it as a single-member LLC; establishing your business as a Limited Liability Company creates a separation between you, the person, and you, the business. This protects you from any personal liability should something happen in your business (for example, if a client or customer took legal action against you, if you were structured as a LLC, they couldn’t come after your personal assets—whereas if you didn’t have the liability protection a LLC offers, your assets could be at risk).

Even though, from a liability perspective, establishing a single-member LLC creates a separate entity for your business, from a tax perspective the IRS doesn’t always view SMLLCs as separate business entities; in fact, the IRS, by default, categorizes single-member limited liability companies as a disregarded entity—which means that the LLC is taxed like a sole proprietorship. 

How Does Being Considered a Disregarded Entity Impact Your Tax Status?

Being categorized as a disregarded entity impacts the way you’re taxed in a few different ways, including:

In addition, depending on what type of business you run and who (if anyone) you end up hiring, as a disregarded entity, you may also be on the hook for additional taxes, like excise tax or payroll tax.

Pros and Cons of Being Categorized As a Disregarded Entity

Like any other business structure, there are pros and cons to being categorized as a disregarded entity.

But what, exactly, are those pros and cons?



Are There Alternatives to Being Classified As a Disregarded Entity For Federal Tax Purposes? 

While the IRS, by default, categorizes single-member LLCs as disregarded entities, it’s not the only entity status option for your business. SMLLCs can also elect to be categorized as a corporation—with many businesses opting to be taxed as an S Corporation (or S Corp).

Being taxed as an S corp changes the structure of your business and how you’re taxed—and, in some situations, can lower your total taxes owed vs. if you stick with your disregarded entity status. If you’re thinking about categorizing your single-member LLC as an S corp, it’s important to talk to a tax professional; while there are certain tax benefits to being taxed as an S corporation (like avoiding self-employment taxes), you’ll also need to implement certain changes in your business (like implementing a payroll service and paying yourself a salary). A tax professional can advise you on the tax implications of changing your entity status, help you determine whether it’s the right fit for your business, and, if so, instruct you on how to file Form 2553 with the IRS and change your tax status.

Use the Entity Status That's the Best Fit for Your Business

As a single-member LLC, your business is automatically categorized as a disregarded entity by the IRS—and for many businesses, that structure is the most advantageous. But being a disregarded entity isn’t the only option—so if you’re concerned that your status is causing you to pay too much in taxes, talk to a tax professional to determine if another classification (like S Corp) could lower your tax burden—and allow you to pocket more of your business profits.

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