Entity Classification and the Check-the-box Rules
Entity classification is not the most exciting topic and as such it is often overlooked by professionals and laypersons alike. However, understanding the entity classification rules can mean the difference between getting the treatment you want and ending up in the proverbial ditch.
Domestic Entity Classification:
In the domestic context, the issue is usually whether an entity is a partnership or a disregarded entity. A partnership with two or more members is treated as a passthrough entity under Subchapter K. (Under state law a partnership is required to have two or more members). Much like a partnership, an LLC with two or more members is also treated as a passthrough. However, a single member LLC is a disregarded entity. Treas. Reg. § 301.7701-3(b)(1). In addition, a partnership or an LLC owned by husband and wife may either be a passthrough entity or a disregarded entity. The classification will usually depend upon whether the entity is formed in a community property state. In a community property state, it is important to review Rev. Proc. 2002-69 to understand the correct treatment and, if necessary, make the required election.
Finally, an eligible entity may want to elect to be treated as a corporation, or to make a second election to be treated as an S-corporation (subject to certain limitations). It is important to carefully consider the classification of an entity in the domestic context so that the right returns are being file and to effectuate the intended tax result(s). Ignoring the default rules and failing to make a desired election can lead to odd results, to say the least.
International Entity Classification:
As a starting point, it is always important to identify whether the entity at issue is a per se corporation or if the entity is eligible to make an election. The IRS has made the first step easy. Treas. Reg. § 301.7701-2(b)(8)(i) lists entities in countries around the world that are considered per se corporations. For example, in Mexico a Sociedad Anonima is a per se corporation, in the United Kingdom a Public Limited Company is a per se corporation, and in Switzerland an Aktiengesellschaft is a per se corporation. A per se corporation will always be treated as a corporation for US federal tax purposes and it is ineligible to make an election to be treated as anything else.
For entities not listed in Treas. Reg. § 301.7701-2(b), an election to be treated as either a partnership, a corporation, or a disregarded entity should be available. It is important that an eligible entity that wants a specific treatment actually make that election. Failure to make an election will usually result in treatment under the default classification rules. In the international context, Treas. Reg. § 301.7701-3(b)(2) provides those default rules. This regulatory framework treats an entity as a partnership if it has two or more members and at least one member does not have limited liability; as an association (corporation), if all members have limited liability; or, as a disregarded entity if the entity it has a single owner that does not have limited liability.
Making the Election:
The Form 8832 is used to elect how an entity will be classified for federal tax purposes. A timely filed election can be effective up to 75 days prior to the filing and up to 12 months after the date of filing. In cases where no timely election was made, the IRS has issued Rev. Proc. 2009-41 to provide taxpayers with some relief. This Revue Procedure allows for an entity, or in some cases, the owner of the entity to make the election within 3 years and 75 days of the requested effective date of the eligible entity’s classification election.
This Revue Procedure can be an important tool in saving an otherwise untimely election. However, it has some special requirements as to how it is filed and what should be included with the filing. It is best to speak with an attorney or qualified CPA about how to file an entity classification election under Rev. Proc. 2009-41.