Over the years, Single Member LLCs (SMLLCs) have grown in popularity among investors and business owners because under the so-called check-the-box regulations, you can generally ignore the existence of a SMLLC for federal tax purposes. When you choose to not treat a SMLLC as a corporation for federal income tax purposes, the entity is disregarded (i.e., it’s a “nothing” for federal income tax purposes). The federal income tax treatment of a disregarded SMLLC is relatively simple because its activities are considered to be conducted directly by the SMLLC’s sole member (owner). For instance, when an individual uses a disregarded SMLLC to own rental real estate, the rental activity is reported on Schedule E of Form 1040. There is no need to file a separate federal income tax return for the SMLLC.
Although you ignore a disregarded SMLLC for federal income tax purposes, it’s not ignored for general state-law purposes. Therefore, a disregarded SMLLC will deliver to its sole member (owner) the liability protection benefits specified by the applicable state’s LLC statute. These liability protection benefits are usually similar to those offered by a corporation. So, with a disregarded SMLLC, you get simple federal income tax treatment combined with corporation-like liability protection.
As a real estate investor, setting up one or several disregarded SMLLCs to own real estate assets addresses the liability exposure problem without adding tax complexity, since no separate federal income tax returns are required for SMLLCs.
While a disregarded SMLLC can work great as a real estate ownership vehicle under the federal income tax rules, watch out for adverse state and local tax considerations. Even if a disregarded SMLLC is not required to pay any entity-level state taxes, most states impose annual registration fees, and some may require the filing of separate returns. For example, California requires SMLLC’s to file an annual return and pay both an $800 minimum tax and LLC fee based on gross receipts.