Tuesday, April 3, 2012

FAQ: What is a disregarded entity?

Doeren Mayhew 
FAQ: What is a disregarded entity?

A disregarded entity refers to a business entity with one owner that is not recognized for tax purposes as an entity separate from its owner.  A single-member LLC ( "SMLLC"), for example, is considered to be a disregarded entity.  For federal and state tax purposes, the sole member of a SMLLC disregards the separate legal status of the SMLLC otherwise in force under state law.

As the result of being "disregarded," the SMLLC does not file a separate tax return.  Rather, its income and loss is reported on the tax return filed by the single member:

  • If the sole owner is an individual, the SMLLC's income and loss is reported on his or her Form 1040, U.S. Individual Income Tax Return.  This method is similar to a sole proprietorship.
  • If the owner is a corporation, the SMLLC's income or loss is reported on the corporation's Form 1120, U.S. Corporation Income Tax Return (or on Form 1120S in the case of an S Corporation.  This treatment is similar to that applied to a corporate branch or division.
A SMLLC is not the only entity treated as a disregarded entity.  Two corporate forms are also disregarded: a qualified subchapter S subsidiary and a qualified REIT subsidiary. However, SMLLCs are by far the most common disregarded entity currently in use.

For federal tax purposes, the SMLLC does not exist.  All its assets and liabilities are treated as owned by the acquiring corporation.

Even though a disregarded entity's tax status is transparent for federal tax purposes, it is not transparent for state law purposes.  For example, an owner of an SMLLC is not personally liable for the debts and obligations of the entity.  However, since the entity is disregarded, the owner is generally treated as the employer of disregarded entity employees for employment tax purposes.

For further details on disregarded entities or how this tax strategy may fit into your business operations, please contact Doeren Mayhew, a Michigan Tax firm located in Troy.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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