What Is a Disregarded Entity?
The IRS (Internal Revenue Service) allows certain entities to be treated as non-existent for federal income tax purposes. An entity in this status is called a disregarded entity — it is, for tax purposes, simply ignored.
The most common disregarded entity is the SMLLC (single-member LLC) — an LLC with a single member. By default, when the sole member is an individual, the IRS attributes all the LLC’s income and expenses directly to the owner, who reports them on Schedule C (business income) or the appropriate section of Form 1040. The LLC files no corporate income tax return; it is fiscally invisible to the IRS.
The owner can elect to have the SMLLC taxed as a C-Corporation by filing Form 8832 (see check-the-box). Once that election is made, the entity is no longer disregarded.
Why a Disregarded Entity Is Not Automatically Transparent in Spain
Here lies the most common misconception: the fact that the IRS ignores an entity does not mean that Spain’s AEAT does the same. Spain applies its own classification test.
The DGT Resolution of February 6, 2020 (BOE-A-2020-2108) establishes three cumulative criteria for a foreign entity to receive flow-through treatment (entidad en atribución de rentas) in Spain:
- The entity is not subject to a personal income tax in its state of formation.
- The entity’s income is attributed to its members under the laws of the state of formation.
- That attribution occurs by the mere act of earning the income, without any distribution being required.
A SMLLC that is a disregarded entity for the IRS may or may not satisfy all three criteria under Spanish law. The DGT does not draw an automatic equivalence: it analyzes whether the LLC, under the law of the state where it was formed, materially meets each of the three requirements.
Binding Ruling DGT V3074-22
In ruling V3074-22, the DGT recognized that a US LLC may have its own legal personality and, in that case, the AEAT treats it as an opaque entity: the Spanish member does not report the LLC’s income in their IRPF while profits remain inside the entity — only when actual distributions (dividends) or direct payments (salary, management fees) are made.
The key question is whether the LLC has recognized legal personality under its state of formation and whether the law of that state requires automatic attribution of income to its members without a distribution. Not every SMLLC that is disregarded by the IRS satisfies all three Spanish criteria.
The Spain-US Asymmetry: A Particularly Delicate Situation
It is entirely possible for a SMLLC to be simultaneously:
- A disregarded entity for the IRS (transparent in the US): the owner reports everything directly.
- An opaque entity for the AEAT (non-transparent in Spain): the owner is only taxed when dividends are received.
This asymmetry creates real complexity: the member may be fully compliant in the US without realizing that Spain imposes a different obligation — or vice versa. Moreover, if the LLC eventually distributes profits, the member could find themselves taxed twice on the same income without being able to offset the US tax paid as a credit in Spain.
The Spain-US tax treaty (2019 Protocol, BOE-A-2019-15166), through its Art. 1.6, attempts to mitigate this asymmetry by allowing the Spanish member to invoke treaty benefits directly with respect to income attributed by the disregarded entity from the US perspective. But the classification asymmetry does not entirely disappear.
At BMC this is one of the first situations we review when a client arrives with a US SMLLC and has recently moved to Spain. The IRS’s classification is only the starting point — the analysis for the AEAT is independent and can lead to a different conclusion.