In this article, we’re answering “What is a disregarded entity?”
This will include a discussion on the use of disregarded entities in the United States. Additionally, we will be answering common questions we receive and comparing disregarded entities to other similar options.
This article is part of our free series on US LLCs, including the application process for opening a business bank account for an LLC, which you can access here.
Feel free to use the table of contents to jump ahead to the sections most relevant to you.
Table of Contents
- What Is a Disregarded Entity?
- What Is the Difference Between Sole Proprietors and Disregarded Entities?
- Frequently Asked Questions
- Ready to Open Accounts With Banks in the USA?
What Is a Disregarded Entity?
A disregarded entity is most commonly a single-member US LLC that has not elected to be treated as a corporation for tax purposes. Income attributed to the entity is therefore passed to the beneficial owner. Disregarded entities are also commonly used for holding purposes, providing legal separation and liability protection between the owner and any underlying assets.
Single-Member LLC vs Small Business
The main difference between a single-member LLC and a small business is that “single-member LLC” refers to a type of US entity while “small business” refers to a classification used by the IRS to determine the size of an entity.
In other words, a single-member LLC can be classified as a small business if it has less than USD 10mm in assets. Likewise, a small business can be classified as a single-member LLC, if it is a US LLC with only one member.
Depending on your business objectives, partners involved, and activities, the appropriate business structure can vary between LLP and an LLC. It’s important to understand how these companies are structured before making a decision.
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What Is the Difference Between Sole Proprietors and Disregarded Entities?
The main difference between sole proprietors and disregarded entities is that sole proprietors are unincorporated and have not registered a formal entity while disregarded entities are incorporated. That said, for tax purposes, both sole proprietors and entities are treated differently.
Likewise, one of the main benefits of using a disregarded entity, like an LLC, is that it can offer additional benefits, liability protections, and even privacy. These specific benefits are not available to sole proprietors, even though these entities are taxed in the same way that a sole proprietor is.
Alternatively, if you’re looking into business banking in the US, you might want to consider how to apply for business credit cards with an EIN only, which we share in the article linked here.
Disregarded Entity
A disregarded entity refers to an entity that is ignored for tax purposes and is not liable for taxable income. Instead, any taxable income is passed onto the beneficial owner of the entity, to be taxed based on their specific tax bracket and residency status. In fact, in certain circumstances, it may be possible for foreign non-residents to operate single-member entities 100% tax-free.
Sole Proprietor
A sole proprietor refers to an individual business owner who directly generates income and is taxable on the personal level. Interestingly, disregarded entities are treated the same as sole proprietors since the income generated by the entity is passed onto the individual instead of being taxed at the corporate level.
That said, if a US LLC elects to be treated as a corporation for tax purposes, it is no longer a disregarded entity, and the specific benefits offered through a disregarded entity would no longer apply. Likewise, the entity would no longer be treated like a sole proprietorship.
Frequently Asked Questions
Below are three of the most common questions we receive from people looking into this topic. If you have further questions you would like to ask our team, don’t hesitate to get in touch.
Does a Disregarded Entity Need an EIN?
Yes, a disregarded entity needs an EIN. In fact, any entity will need an EIN to complete the most basic required tasks, including opening bank accounts, entering contracts, and even filing taxes. For reference, EIN refers to the Employer Identification Number that all business entities in the United States are issued.
What Does It Mean to Be a Disregarded Entity?
What it means to be a disregarded entity is that a business is ignored for tax purposes. In other words, the entity is not liable to pay any taxes. Instead, the taxes derived from the income generated by the entity are passed on to the beneficial owner.
What Are the Benefits of a Disregarded Entity?
The benefits of a disregarded entity are what most people refer to as pass-through benefits or tax-efficient benefits. In other words, the income generated by the LLC passes through to the beneficial owner, and is then taxed at the personal level instead of the corporate level. This avoids double taxation (corporate and personal) but it can also push the individual into a higher personal tax bracket.
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