Everyone wants to be in the point of financial stability where someone doesn’t have to worry about every dollar for their expenses. When someone is financially stable, there are less worries in life and more experiences to enjoy. In short, once money is no longer a problem, people can really start to experience beautiful things that life has to offer.
One of the most popular ideas to attain financial stability is growing a business and making it successful enough to maintain a certain lifestyle. When business thrives, so does the owner, and that’s the reason why a lot of people think about getting into the business world when they already have enough funds. With the Tax Cuts and Jobs Act, more and more people are attracted to building businesses.
Now that the tax season is almost over, business owners, as well as individual taxpayers, are trying to file their tax returns just in time before the tax season ends. A lot of confusion can arise when filing tax returns, and this includes the confusion regarding the disregarded entity. What is a disregarded entity and why should every business owners care about this rule? The important things you need to know about this rule will be discussed in this article.
What Is a Disregarded Entity?
A disregarded entity, in its very basic definition, is a business that the Internal Revenue Service (IRS) and states ignore for the purpose of taxation even though they are separate from the business owner. The biggest confusion lies around the rule for partnerships and corporations where owners have limited liability and are only liable with the amount of their investment. To clear the confusion, a disregarded entity is only deemed not separate from the owner’s affairs in the eye of IRS for tax purposes.
In short, business entities that qualify as separate entities are still separate from their owners when it comes to liabilities. But when it comes to tax purposes, the business will be taxed through the individual’s personal tax return.
In practice, there is only one disregarded entity: Single-Member LLCs. All the single-member LLCs or SMLLCs are deemed disregarded entity except when it elects to be treated as a corporation. Meanwhile, a single proprietorship business is not separate from the owner, which means that the liability of the business is the liability of the owner, and is therefore not treated as a disregarded entity.
The Pros Of Disregarded Entity
- It is a way to avoid double taxation
Corporations, partnerships, and other types that are taxed through corporate tax know the struggle of double taxation. However, this is not a problem for disregarded entities because of its advantage known as pass-through taxation. Owners of corporations usually pay taxes twice: the first one is with the corporate income tax rate of 21%. In addition to it, the shareholders must pay for personal taxes on dividends. A disregarded entity will only need to pay taxes at personal levels.
- Limited Liability Protection
On top of being exempt in the corporate income tax, disregarded entities also enjoy limited liability protection. For small businesses, being an SMLLC is the sweet spot of the equation where the benefits of both the corporation and sole proprietorship are combined. When the business is being sued, the personal properties of the owner cannot be collected to pay the liabilities of the business.
- It Makes Filing Taxes Easier
Disregarded entity owners enjoy the ease of filing taxes. This is because all of the business income and expenses will be reported on a personal tax return that follows Schedule C, which is another advantage that it got from a sole proprietorship. The owner would pay taxes using the personal income tax rate. On top of that, a 20% deduction is available starting this year because of the Trump Tax Plan.
The Cons Of Disregarded Entity
Disregarded entity takes the most balanced spot for people who like the best of sole proprietorship and corporation. However, because there is liability protection where the owner’s properties cannot be touched, it is harder to raise funds for expansion or for investment. There is also a lesser amount of tax someone can claim as a deduction. Last but not least, a disregarded entity might be responsible for other types of taxes like payroll taxes and employment taxes.
When To Call A Professional?
Are you unsure if your business is qualified as a disregarded entity? Is there still any confusion that is not addressed in this article? It is recommended to call a tax professional in order to help you with your taxes this tax season and also to avoid paying more taxes than necessary.