The start of a new year means tax deadlines are fast approaching. Part and parcel of running a successful business is finding ways to strategically minimize your tax burden.
To that end, we’ve prepared a guide on arguably one of the most important choices you can make during tax time: electing to file as a disregarded entity.
A disregarded entity (DE) is a tax/accounting term used to denote a business that is “disregarded” by the IRS for tax purposes. This means that business income will be taxed as the owner’s personal income.
In other words, disregarded entities are taxed as if you hadn’t incorporated a business at all. There are multiple types of disregarded entities to choose from when filing your taxes. Here are some of the most common.
The most common disregarded entity is a single-member LLC. This structure is automatically taxed as a disregarded entity by the IRS, without the need to file Form 8832.
Note that even though income tax only applies to the owner, the LLC will still be taxed as a separate entity for employment and certain excise taxes, where applicable.
Admittedly uncommon, an LLC owned by two spouses can be treated as a disregarded entity that is also in a state with community property laws. The IRS notes three conditions that need to be met for an entity to qualify for this tax status:
Technically not considered disregarded entities by the IRS, business structures that have their revenue directly passed to the owners achieve the same effect. By having the company’s revenue attributed to the owners alone, these entities won’t be taxed themselves–just the owners.
Below is a list of the most well-known structures.
Choosing a business model that can be taxed — or treated — as a disregarded entity confers many different advantages that otherwise might not be available. These are three of the most substantial benefits.
With some corporate structures, the owner and the entity are taxed separately. This leads to double taxation — for example, paying corporate tax on business income plus personal income tax on your own salary. In the case of a disregarded entity (or other pass-through entity), only the owner is taxed.
LLCs allow the owner to obtain limited liability protection, unlike sole proprietorships for example. Practically speaking, this limits courts, creditors, and other adverse parties from claiming assets from the owner of the business. This is assuming no personal guarantees have been put in place, which would hold the owner personally liable.
Interested in learning more about LLCs and sole proprietorships? Check out our guide.
With income passing through to the owner for tax purposes, only one tax return needs to be filed each year. If you file their own taxes, this means less paperwork and more time making your business profitable. If you outsource their taxes, you will likely pay fewer fees than those with multiple returns.
We’ve covered the different disregarded entities and their benefits, but what about other business structures? How are they taxed?
LLCs that contain more than one member cannot be treated as a disregarded entity, but they still have some flexibility during tax season. A multi-member LLC will be taxed as a partnership unless it files Form 8832 and elects to be taxed as a corporation.
C-Corps have to file taxes as corporations, so they don’t have the same flexibility as LLCs. This leads to double taxation since the corporation itself is taxed along with any individual shareholders that received dividends.
Choosing a business structure that is treated as a disregarded entity allows for strategic tax planning and can help you save money as a business owner. With inflation and interest rates continuing to rise, it's beyond prudent to make the most of your dollars.
Incorporating an LLC gives you critical liability protections while allowing you to file taxes as a disregarded entity. If you’re ready to incorporate your business, hit the link below to create your LLC or C-Corp in a matter of minutes.
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