Using a Disregarded Entity to Accomplish Your Business Objectives
 

What Is a Disregarded Entity?

A disregarded entity is a separate legal entity for state law purposes that provides limited liability protection to its owner or, in certain circumstances, owners. Typically, a disregarded entity will have a single owner and will take the form of either a limited liability company or a wholly-owned subsidiary of a S corporation. While most disregarded entities have a single owner, in limited circumstances a disregarded entity may have two owners. For example, a limited liability company may be owned jointly by a husband and wife living in a community property state and treated as a disregarded entity for federal income tax purposes.
 

Federal Income Tax Treatment of a Disregarded Entity

For federal income tax purposes, the assets of a disregarded entity are generally treated as being owned directly by its owner. As a result, a disregarded entity is not required to file a separate federal income tax return, but rather all items of income, deductions, and loss are included in the federal income tax return of its owner.
 

Texas Franchise Tax Treatment of a Disregarded Entity

A disregarded entity in its typical form of a limited liability company or S corporation subsidiary will likely be subject to the Texas franchise tax which often makes the use of a disregarded entity in Texas less attractive. Through proper structuring, however, it is possible to form and operate a business in Texas as a limited partnership that is a disregarded entity for federal income tax purposes and not subject to the Texas franchise tax.
 

Why Use a Disregarded Entity?

While there are many uses of a disregarded entity, the following is a summary of some of the more typical uses of a disregarded entity:

• An individual desiring to operate a small business may form a single member limited liability company. The individual owner would achieve limited liability protection from liabilities arising out of the operation of the business and report the income and loss from the business on the individual's federal income tax return.
• An individual desiring to acquire rental property may acquire such rental property through a single member limited liability company. The individual would be able to avoid personal liability for potential environmental clean-up liabilities associated with the rental property as the legal title to the rental property would never be in the individual's name which such fact alone could trigger personal liability. The individual would report items of income and loss on the individual's federal income tax return.
• An individual, corporation or other business entity may use a limited liability company to acquire replacement property in a like-kind exchange without incurring potential environmental liability exposure as an owner in the chain of title of the replacement property.
• A corporation may use a disregarded entity to develop a new product or operate a separate line of business while insulating its existing assets and business from any liabilities incurred as a result of the new product or line of business. All items of income and loss would be reported on the corporation's federal income tax return.
• A corporation desiring to acquire another corporation through a tax-free reorganization may form a limited liability company for purposes of acquiring the target business in a tax-free merger to provide insulation of its existing assets and business from liabilities of the target corporation and report all items of income and loss from operations of the acquired target corporation's business on its federal income tax return.
   

Conclusion

The use of a disregarded entity can provide limited liability protection for business operations without creating additional federal income tax liabilities or cumbersome filing requirements. If you find one of the above uses of disregarded entities to be attractive for your business needs or would like to discuss other uses of disregarded entities to accomplish your business goals, please consult a Strasburger tax attorney to determine whether a disregarded entity is the right planning tool to accomplish your desired business objectives.

     
STRASBURGER & PRICE, LLP  •  DISCLAIMER
Articles contained within this newsletter provide information on general legal issues and are not intended to provide advice on any specific legal matter or factual situation. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel.