What is a DRE (Disregarded Entity) and when do you need to set one up?

So if I understand right, a DRE gives you the legal benefits of an LLC but you still file taxes like a sole proprietor? Does that mean I'd still use my SSN for everything or do I need an EIN?

You've got it exactly right - you get the liability protection of an LLC but the tax simplicity of a sole proprietor. For tax ID purposes, you can use your SSN for most things, but many people still get an EIN (Employer Identification Number) for their DRE. It's free to get from the IRS and keeps you from having to give out your SSN to clients. Some banks also require an EIN to open a business account, even for a DRE.

How exactly does it work? Do you just upload tax documents and it explains them or does it give actual advice on what business structure to choose?

Sounds interesting but I'm skeptical... Does it just give general info you could find on IRS website or does it actually customize the advice to your specific situation?

The way it works is you upload any tax documents or business formation papers you have, and it analyzes them completely. It highlighted all the parts about disregarded entities that applied to my situation and explained the implications in simple terms. It definitely gives customized information based on your specific documents and questions. It's way more helpful than the IRS website because it actually points out which parts are relevant to your situation and explains what they mean in normal human language, not tax jargon.

Wait, how does this actually work? They somehow get you through the IRS phone system faster? Seems too good to be true.

Yeah right. I've tried EVERYTHING to get through to the IRS and nothing works. You expect me to believe this service somehow magically gets you to the front of the line? The IRS phone system is literally designed to make you give up.

It works by essentially handling the waiting for you. They have a system that navigates through the IRS phone tree and waits on hold, then when they actually reach an agent, they call you and connect you. It's not magic - just technology that does the painful waiting part for you. I was super skeptical too. I'd spent hours on hold multiple times and gave up. But this actually works - they called me back when they reached an agent and transferred me directly. Saved me hours of my life and I got my DRE tax questions answered.

Is that true for all states or just California? I'm in Texas and trying to figure out if I need to file anything special for my DRE.

It varies by state, which is what makes it confusing. Texas is actually one of the better states for this since they don't have a state income tax, but they do have a franchise tax that applies to LLCs, including DREs. However, there's a "no tax due" threshold of $1.23 million in annual revenue, so most small businesses don't end up owing anything. You still need to file the "No Tax Due" form if your revenue is under that threshold, though. It's pretty simple but easy to overlook if you don't know about it.

Yes, exactly! Once you add a second member to your LLC, it automatically stops being a disregarded entity and becomes a partnership for tax purposes (unless you elect to be taxed as an S-Corp or C-Corp). This means you'll need to file Form 1065 (partnership return) instead of just reporting everything on your Schedule C.

Great question! The transition from DRE to partnership happens automatically when you add that second member - no special election needed. The IRS will just start treating your LLC as a partnership for tax purposes from that point forward. The process itself isn't too complicated, but there are some things to plan for: you'll need to get familiar with partnership tax filings (Form 1065), and you'll want to have an operating agreement in place that spells out profit/loss sharing, management responsibilities, etc. The partnership will also need to establish its own tax year and accounting methods. One tip: consider talking to a tax professional before adding that partner. They can help you think through the timing (like whether to add them at the beginning of a tax year to keep things cleaner) and make sure you understand how the profit/loss allocations will work on your taxes.

Even though your DRE is "disregarded" for tax purposes, you definitely still want to keep a separate business bank account! This is super important for maintaining what's called the "corporate veil" - the legal separation between you and your LLC that gives you liability protection. If you mix personal and business funds, it's called "commingling" and it can actually pierce that corporate veil in a lawsuit. A court could decide your LLC isn't really separate from you personally and hold you liable for business debts. Plus, having separate accounts makes bookkeeping SO much easier when tax time comes around. Even though everything flows through to your personal return, you still need to track business income and expenses accurately for Schedule C. Trust me, trying to sort through mixed transactions later is a nightmare! Most banks will let you open a business account for your DRE using either your SSN or an EIN. Just bring your LLC formation documents and you should be good to go.

Great questions about the timing! For the mid-year LLC formation, it's actually simpler than you might think - since a DRE is disregarded for tax purposes, all your freelance income for the entire year (both pre-LLC and post-LLC) gets reported on the same Schedule C. The IRS doesn't distinguish between your sole proprietor months and your DRE months since you're the same taxpayer either way. As for quarterly estimated taxes, having a DRE doesn't really change the calculation compared to sole proprietorship. You're still paying self-employment tax on your net business income, and the quarterly payment process is identical. Just keep using Form 1040ES like you have been. The main thing is making sure you adjust your estimates if your income changes significantly after forming the LLC, but that would be true for any business structure change. One small tip: when you do form the LLC mid-year, make sure to keep good records of which income came from which time period, even though it all goes on the same tax form. It can be helpful for your own bookkeeping and if you ever need to track business performance metrics.

Thanks for adding the professional perspective, @Dylan Mitchell! The point about professional liability insurance is really important - I hadn't thought about that distinction between business debts and personal negligence. Quick question about the S-Corp election you mentioned - at what income level does it typically make sense to consider that switch? I'm just starting out with my web design business, but it's good to know what benchmarks to watch for as things hopefully grow. And is that something you can elect into and out of easily, or is it more of a permanent decision once you make it? Also really appreciate the clarification about liability protection not being absolute. I think a lot of us newcomers assume an LLC is like a magic shield, so it's good to understand the limitations upfront.