1. What Are Disregarded Entities?
2. State Taxes and Disregarded Entities
3. Drawbacks of Disregarded Entities
4. Paying Disregarded Entity Taxes

A disregarded entity S corp is just one of several disregarded entities you could establish. With a disregarded business entity, a business's income and assets are not considered for the purpose of federal taxation. Instead, these items get taxed on the personal return of the business owner.

What Are Disregarded Entities?

When it comes to federal taxation, the Internal Revenue Service (IRS) ignores disregarded entities. Any income earned by a disregarded entity will get taxed, but will be treated as the business owner's personal income. You should be very careful when planning your taxes while operating a disregarded entity.

There are three primary types of disregarded entities:

  • Single-member LLCs: These limited liability companies form at the state level and have only one member.
  • S Corporations: These corporations have made a special tax election with the IRS. With an S corporation, business income passes to company members and gets only taxed once, on their personal returns.
  • Check the Box: These entities can decide whether to get taxed as a corporation or treated as a disregarded entity. Generally, check-the-box entities are businesses in the United States that receive income from foreign entities.

Limiting personal liability while controlling taxes is the main purpose of a disregarded entity. In the past, it was considered a rule that liability protections required an addition tax burden. Today, limiting a business owner's personal liability does not require additional taxation for most entities.

State Taxes and Disregarded Entities

In some states, a business's disregarded entity status will be ignored, and the business will get taxed as a corporation. While these states may not tax disregarded entities, they will charge fees that would apply to corporations, which can be very expensive.

A mistake that many make related to disregarded entities is assuming that these businesses are not required to pay any taxes. While it's true that disregarded entities are ignored for federal taxation, there are numerous state taxes that disregarded entities must pay:

  • Property tax
  • Sales tax
  • Use tax

Disregarded entities must also comply with state-level reporting requirements and fee payments. So, if the owners of a disregarded entity make a sale, this sale would not be subject to federal taxation but would be subject to sales taxes.

Drawbacks of Disregarded Entities

If your disregarding entity has employees, you will need to comply with the same withholding rules as normal entities. Disregarded entities can be easily mishandled, especially when it comes to taxes. If you're not careful, you could end up facing a larger tax bill than you expect.

You must be very careful if you're performing international transactions with your disregarded entity. For instance, while your business will be considered a disregarded entity in the United States, you may not be treated as a disregarded entity in other countries.

While operating your disregarded entity, you should also make sure that you are paying any required state-level taxes. All business transactions, including corporate acquisitions, are subject to sales and use taxes. If you fail to pay these taxes, you will likely face hefty penalties.

Paying Disregarded Entity Taxes

When paying taxes for your disregarded entity, you will use a W9 form. To make sure you pay your taxes correctly, you must be certain that your W9 form includes the correct information. For instance, you will need to include the same legal name that you will use on your federal tax return. You should link any tax ID number that you use on this form to your legal name.

If your disregarded entity is a single-member LLC, the name you include on your W9 form should be your company owner's name. Do not use the name of the LLC.

The tax identification and classification that you use for your disregarded entity single-member LLC can fall into one of three categories:

  • If the owner of the LLC is an individual, you should choose the sole proprietor classification and use your Social Security Number.
  • Single-member LLCs owned by a partnership or corporation should use these classifications and include the Employer Identification Number (EIN).
  • Single-member LLCs owned by another LLC should choose the LLC classification and include the EIN.

Make sure you are choosing the correct classification and identification before you submit your W9 form.

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