Learn About Business Entities
A business entity is an organization created by one or more natural persons to carry on a trade or business. Business entities are created or formed at the state level, often by filing documents with a state agency such as the Secretary of State. Types of business entities include corporations, partnerships, limited liability companies, limited liability partnerships.
When we talk about entities, we are referring to the type or structure of the business (for example, a corporation) as opposed to what the business does (for example, carpet cleaning services).
Business entities are subject to taxation and must file a tax return. Some business entities are considered for federal tax purposes to be not separate from its owner. Such is the case with single-member limited liability companies and sole proprietors. The income and deductions related to such entities are reported on the same tax return as the owner of the business. We call these disregarded entities because the IRS "disregards" the separate name and structure of the business.
A disregarded entity can choose to be treated as if it were a separate entity. This is done by making an Entity Classification Election using Form 8832 and filing this form with the IRS. The purpose of this form is to choose a classification other than the default classification provided by federal tax laws.
For example, suppose John is the sole-owner of XYZ LLC. As a single-member limited liability company, XYZ would be a disregarded entity. The IRS would expect John to report his business income and expenses on a Schedule C filed with his personal Form 1040. In other words, XYZ LLC is being treated as a sole proprietorship by default. John could choose to treat XYZ LLC as if it were a corporation. To do so, he would file the Form 8832 to make his choice known to the IRS.
Thus we distinguish between entities, which is the actual organizational structure created under state law, from its tax classification. The confusion is that we use the same words for both concepts.
Colloquially, when accountants talk about "entities" or "entity returns," they are referring to tax returns other than for individual people.