A disregarded entity is a legal entity with a single owner that is not separate from its owner for U.S. federal tax purposes. So, as the name implies, the legal entity is disregarded for federal tax purposes.
The disregarded entity concept is typically associated with single-member LLCs. A U.S. limited liability company (LLC) is a domestic eligible entity. Within certain limitations, a domestic eligible entity can generally elect its tax classification for federal tax purposes.
In contrast, a corporation is generally not an eligible entity and must remain a “C” corporation for federal tax purposes. Under certain circumstances, a corporation may elect S corporation tax treatment.
Under 26 CFR § 301.7701-3(b)(1), a domestic eligible entity is, in the absence of an election otherwise, a partnership if it has two or more members and disregarded as an entity separate from its owner if it has a single owner.
The disregarded LLC has flow-through treatment for federal tax purposes, meaning the single member treats all of the LLC’s income, expenses, credits, assets, and liabilities as if the single member owned them directly. What are some examples?
Disregarded LLC Owned by Individual
John is an individual who formed a Delaware LLC and owns 100% of the LLC’s units. The entity is, by default, treated as a disregarded entity for federal tax purposes, and John does NOT file an “S” or “C” corporation election.
John uses the LLC to operate a marketing consulting business. The LLC does not file a separate income tax return. Because the LLC is a disregarded entity, John reports all of the income & expenses directly on Form 1040 Schedule C (Profit or Loss From Business).
Disregarded LLC Owned by Corporation
Parent Company Inc. is a Delaware corporation taxed as a “C” corporation for federal tax purposes. Parent Company Inc. forms a Delaware LLC and owns 100% LLC membership units. The LLC did not file a “C” corporation election. The LLC is a single-member LLC and disregarded entity for federal tax purposes, so the LLC does not file a separate tax return.
Parent Company Inc. consolidates all the activity as if the LLC didn’t exist. Parent Company Inc. files Form 1120 (US Corporation Income Tax Return) and reports the LLC’s income and expenses directly on Page 1 of Form 1120. The LLC’s assets and liabilities are consolidated with the parent company and reported on Schedule L (Form 1120).