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What is a Disregarded Entity?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 08 November 2016
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A disregarded entity is a business entity considered separate from the owner when it comes to liability and the same as the owner for tax purposes. The owner claims the business on personal taxes, but when liability issues arise, the owner's personal assets are protected. There are a number of advantages to setting up a business as a disregarded entity. People who want to treat a business as a disregarded entity should consult attorneys and accountants to make sure it is appropriate and to confirm that it is done correctly.

Claiming a business on personal taxes provides some convenience for the owner, including not having to file a separate tax return for the business and being able to use simpler tax forms. In addition, losses from the business can be used to offset tax liability when the business is personally claimed. For this reason, people may find it advantageous to have the separate status of a business disregarded when it comes to taxes.

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The disadvantage of associating a business directly with the owner, as seen with a sole proprietorship, is that if the business incurs liabilities, the owner shares those liabilities. A contractor operating a sole proprietorship, for example, could lose personal assets in a lawsuit. For this reason, many people want to set up businesses as separate entities, like wholly owned subsidiaries and corporations. Under the law, a disregarded entity is treated as separate from the owner when questions of legal liability arise, and this provides people with limited liability protection.

Typically, a disregarded entity is owned by a single person, although a partnership may be used, especially if it is a husband and wife partnership. Regulations about classification of businesses for tax and liability purposes are very strict and not all businesses can be treated as disregarded entities. If there is uncertainty about how the government will classify a business, people can consult attorneys for advice and get information on whether it is possible to change the classification.

Shifting liability is important for many business owners, as they want to avoid losing everything if a problem occurs with the business. The law on liability can be very complex, and there are often multiple regulations involved. It is important to understand how liability works, preferably before a problem happens, so people can prepare appropriately. There are a number of protections available when people classify their businesses appropriately and make sure to abide by the laws surrounding businesses in those protected classes.

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hamje32
Post 2

@SkyWhisperer - There are benefits, for sure, but the benefits for tax purposes are a little more unclear. For example even if you are set up as a single entity LLC, you still have to file Schedule C and you have to pay self employment tax.

I think it’s fifteen percent or something like that. However if you set yourself up as an S corporation the tax rate is less from what I understand. I don’t know how easy it is to set up as an S corporation but the point is that the corporate rates will be cheaper.

SkyWhisperer
Post 1

Every time you turn on the television you see some lawyer advertising the benefits of setting yourself up as an LLC entity (limited liability corporation), to protect yourself from personal loss in case something happens to your business.

It seems to make sense and there’s really no reason not to; you can get set up as an LLC fairly cheaply. I have even seen some freelance writers set themselves up this way.

That might sound strange – after all, what can kind of trouble could a freelancer get into? All I can say is that there is always a time for everything, especially since we live in a litigious society.

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