New York LLC
The pros of a disregarded entity include pass-through taxation and simplified business structure, but the cons involve limited liability protection and potential self-employment taxes for the owner.
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Last Updated: March 12, 2026
Most new business owners have heard of LLCs and corporations. But what about the term “disregarded entity?” It’s a taxation term that’s most often applied to an LLC with only one owner. This guide discusses what a disregarded entity is and its pluses and minuses.
The disregarded entity definition comes from the IRC (Internal Revenue Code). It describes the tax filing method where the IRS “disregards” or ignores the entity for income tax purposes. The term “disregarded entity” refers to a tax classification instead of an entity type. A business owner must create a disregarded tax entity (like an LLC) before they can receive disregarded entity tax treatment.
When the IRS considers a business a disregarded entity for tax purposes, it doesn’t pay federal business income taxes. Instead, the entity owner pays income tax for the disregarded entity on their personal income tax return.
It’s important to remember that the IRS disregarded entity classification only applies to federal taxes. A business owner’s state Department of Revenue will tax the business under state law, which could require business income taxes, depending on the state.
Only certain business structure options can be classified as disregarded entities. Single-member LLCs are considered disregarded entities. Multi-member LLCs, S corps (please see the What is an S Corp? page for more information), and partnerships don’t fall under this label.
An LLC is a popular business structure for freelancers and entrepreneurs. It’s also a relatively new type of business structure formed under state law. As a result, the IRC doesn’t provide a specific taxation method for LLCs. Instead, the IRS taxes an LLC under the existing tax structures in the IRC. By default, an LLC is taxed as a partnership or sole proprietorship (disregarded entity), and some business entities need an EIN depending on their structure. Learn more about EIN requirements here.
The default tax classification for an LLC depends on how many members it has. If the LLC has at least two members, the IRS taxes it as a partnership by default. The default classification for a single-member LLC is disregarded entity. So, if someone starts an LLC by themselves, creating a single-member LLC, they’ll be a disregarded entity. The LLC won’t file a federal tax return, but the owner must report the business income on their individual return.
Certain trusts can also be a disregarded entity. However, only “grantor trusts” are disregarded entities. A grantor trust is when the owner controls the income and assets of the trust. In that case, the grantor (not the trust) must pay taxes on the trust’s income.
There are advantages to being a disregarded entity. Some of the pros include tax benefits and easy tax filing.
The biggest advantage of the disregarded entity is pass-through taxation. Single-member LLC taxes eliminate corporate double taxation by passing on profits to the owner. LLC members aren’t considered employees and don’t pay employment taxes on a paycheck. Instead, the owner will pay self-employment taxes on the business income. When they provide a client with a W-9 for the disregarded entity, they’ll receive a disregarded entity 1099 (1099-NEC).
Additionally, a business owner can choose to change the taxation method for their disregarded LLC in a future tax year. An owner can elect corporate taxation by filing Form 8832 as a single-member LLC (if they think that will benefit their company). If the business qualifies, the owner can file Form 2553 for S corp classification. S corp taxation means the owner can pay themselves a salary, paying employment taxes only on that salary and not on the remaining profits they receive as distributions. For some LLCs, this could add up to thousands of dollars in tax savings. Read the pass-through taxation definition for more information.
As a disregarded entity, an LLC doesn’t file a tax return as a separate entity. Instead, owners report taxable income on their personal tax returns by filing Schedule C with Form 1040. The owner will pay self-employment tax on business earnings, but they don’t have to file a corporate income tax return.
An LLC is one of the most popular options for small businesses because it provides its owners with liability protection. Since an LLC is a legal entity, owners are protected from personal liability for business debts and obligations. Personal liability protects the owner’s personal assets separate from the business.
If someone owns a single-member LLC, they’re a disregarded entity for tax purposes, enjoying the tax benefits of that status. But the LLC is still a separate legal entity with liability protections; this protection is the primary distinction between a single-member LLC and a sole proprietorship.
While treating an LLC as a disregarded entity has several advantages, there are also downsides to consider.
As opposed to a corporation, as a disregarded entity, it’s harder for an entrepreneur to get money from investors when they want to grow their business. Disregarded entities are considered less credible than larger business entities, such as corporations. Most investors choose to put their money into corporations since they can buy shares in a company that provides more security. To learn more about equity structures, read this guide: Phantom Equity v. True Equity.
As a disregarded entity, a business owner is responsible for self-employment taxes, which are the taxes earmarked for Social Security and Medicare.
The owner of a disregarded entity is considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay part of them.
This can be partially offset by electing to be taxed as an S corp. When the disregarded entity elects S corp status, the owner can be compensated in two ways: by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay self-employment taxes on their salary, not on the profits they receive. Of course, this is only for self-employment taxes; LLC members still must pay income and other applicable taxes on their profits. This can add up to quite a lot for certain profitable LLCs. To get a better idea, check out the S corp tax calculator.
One caveat to S corp election is that the IRS expects a business owner to pay themselves a “reasonable salary” as an employee of the LLC. Otherwise, the owner could pay themselves an annual salary of $1 and avoid contributing anything to Social Security and Medicare. The IRS considers “reasonable” to be something similar to what others in the same field are earning.
Related: Exempt vs. Nonexempt Employees
To set up a disregarded entity, start by forming an eligible legal business entity. Starting an LLC is a great option for a small business (those who are still considering where to form their LLC should check out the Pros and Cons of Incorporating in Delaware guide). Still, it’s a good idea to consult with an accountant about the tax consequences of starting an LLC.
ZenBusiness can help make the tax process easier and help entrepreneurs send invoices and track expenses with ZenBusiness Money Pro.
To form an LLC, an entrepreneur will need to head to their state’s Secretary of State or Division of Corporations office. Forming an LLC usually requires filing Articles of Organization. It’s important to review state requirements before filing (or let ZenBusiness help with their LLC formation services).
ZenBusiness offers fast, accurate LLC formation online, guaranteed. Their services provide long-term business support to help anyone start, run, and grow a business.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. For specific questions about any of these topics, seek the counsel of a licensed professional.
A disregarded entity is a federal income tax classification, while an LLC is a business structure formed under a state statute. The IRS doesn’t have a set taxation method for LLC income. Instead, the IRS taxes LLCs by default, depending on the number of members. A multi-member LLC is taxed as a partnership, and a single-member LLC is a disregarded entity.
The IRS ignores disregarded entities for federal tax purposes. Thus, disregarded entities don’t pay income taxes. It’s the individual owner’s responsibility to pay income taxes on the business’s profits.
Yes. Single-member LLC owners must report income from the disregarded entity on their individual income tax returns.
A disregarded entity isn’t inherently good or bad. It’s another approach to paying business taxes. If a person finds themselves wondering about the specific impacts on their tax liability, it’s best to consult a tax professional.
If a married couple lives in a community property state, they can share joint ownership of an LLC. In that case, the IRS will honor the couple’s decision to treat the LLC as a disregarded entity. In non-community property states, an LLC owned by a husband and wife can’t be a disregarded entity.
No. A corporation can’t be a disregarded entity because it uses corporate taxation. However, an LLC can elect to be taxed as a C corporation and pay the corporate tax rate.
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