Disregarded Entities

Scope of the chapter. A domestic LLC with one owner that does not elect to be classified as a corporation is disregarded as an entity separate from its owner for federal tax purposes. Treas. Reg. § 301.7701-3(b)(1)(ii). Most single-member LLCs in the United States are taxed in this way, and so are many LLCs with two members under state law that have one owner for tax purposes. This chapter examines what disregarded status means, who may own a disregarded entity and how each kind of owner reports its activities, the taxes and reporting regimes for which the regulations treat the entity as separate from its owner, the collection of federal taxes from the owner and from the entity, the tax consequences of changes in the number of members and of elective changes in classification, the use of disregarded entities in mergers, exchanges and gifts, and the international and state tax questions that disregarded status raises.

Why disregarded status needs its own chapter. Disregarded status looks simple. The entity files no federal income tax return, and its items appear on the owner's return. The simplicity is deceptive for three reasons. First, the regulations do not disregard the entity for every purpose. They treat it as a corporation for employment taxes, for a list of excise taxes and for the information reporting required of foreign-owned domestic corporations, and as a separate entity for tax liabilities that arose while it was regarded. Second, federal tax law disregards the entity while state law continues to treat it as a separate person that owns its own property, and the collision between the two systems determines what a tax creditor may reach, how a transfer of an interest is valued for gift tax purposes and which entity must sign a return or a consent. Third, the status changes automatically when a second member is admitted or when the membership falls to one, and those changes are taxable events whose consequences the members often do not anticipate.

Relation to other chapters. The classification regulations as a whole, including the election procedure on Form 8832, the per se corporation list and the default rules for foreign entities, are examined supra ch. 39. The business law of the single-member LLC, including its recognition under state statutes, the single-member operating agreement, veil piercing, charging orders and bankruptcy of the sole member, is examined supra ch. 9, which also contains a short summary of the tax treatment at ¶ 930. Partnership taxation, which applies when a disregarded entity admits a second member, is examined supra ch. 40 and infra ch. 41. The S corporation election, which a single-member LLC may make after electing to be an association, is examined infra ch. 43. Self-employment tax is examined infra ch. 45, state taxation and foreign members infra ch. 46, beneficial-ownership reporting infra ch. 48, bankruptcy infra ch. 49 and estate planning infra ch. 50. This chapter refers to those chapters and does not repeat them.

Organization. The chapter proceeds in nine parts:

• the meaning of disregarded status, the validity of the regulations and the continued separate existence of the entity under state law (¶ 4210);
• the owners of disregarded entities and how each reports the entity's activities, with a comparison to qualified subchapter S subsidiaries and qualified REIT subsidiaries (¶ 4220);
• the purposes for which the regulations treat a disregarded entity as separate from its owner, principally employment taxes, certain excise taxes and liabilities from periods in which it was regarded (¶ 4230);
• taxpayer identification numbers, withholding certificates, backup withholding and the reporting regime for foreign-owned disregarded entities (¶ 4240);
• the collection of federal taxes, including liens, levies, the alter ego and nominee theories and transferee liability (¶ 4250);
• changes in the number of members, elective changes in classification, mergers into and out of disregarded entities and sales and exchanges of disregarded entities (¶ 4260);
• estate and gift planning with disregarded entities (¶ 4270);
• international aspects (¶ 4280); and
• state taxation, bankruptcy, a summary table and a checklist (¶ 4290).

Terminology. This chapter uses "disregarded entity" for any business entity that is disregarded as an entity separate from its owner under Treas. Reg. § 301.7701-2(c)(2)(i) and § 301.7701-3, and "owner" for the person whose return reports the entity's activities. A disregarded entity need not be an LLC. A wholly owned limited partnership in which the general partner is itself a disregarded entity of the sole limited partner, or a foreign eligible entity that has elected disregarded status, is also a disregarded entity. Because the subject of this treatise is the LLC, the examples use LLCs throughout.