The nature of today’s global society propels an increasing number of U.S. companies to operate lines of business internationally as they seek new markets or try to cut costs. This movement into foreign countries can bring with it unintended consequences unless the appropriate entity classification election is made for U.S. tax purposes.
The central form in the classification election process is IRS Form 8832, “Entity Classification Election”, which is based on Treasury Regulations Sections 301.7701-1 through 301.7701-3. Filing this form is often referred to as “checking the box”, as the taxpayer actually checks a box and selects how he or she wants the business to be treated for U.S. tax purposes.
On Form 8832, the entity can choose to be classified as a corporation, a partnership or a disregarded entity. All of these entity options entail various consequences for U.S. tax purposes. For example, if the entity is treated as a partnership, the income/losses flow through to the owner’s U.S. tax returns along with any associated foreign tax credits.
The entity election will be effective on the date specified on Form 8832, or on the filing date. The specified date cannot be more than 75 days prior to the filing date, and the effective date cannot be later than 12 months after the filing date. (Under certain circumstances, late election relief may be available.)
In order to prove that an entity election was filed, it is recommended that the entity election be sent via certified mail. The IRS generally responds within 60 days of filing, notifying an entity of whether its election was accepted.
Although many entities have a choice of how they want to be treated for U.S. tax purposes, certain entities do not have a choice. The instructions for Form 8832 include a list of those entities (sometimes referred to as “per se corporations”). These businesses have only one option-to be classified as corporations for U.S. tax purposes. Examples of these kinds of entities are public companies, such as the Public Limited Company in the U.K. and the Société Anonyme in France.
If an entity classification is not filed with the IRS, there are certain default rules under which the business will fall. The key for the default classification is whether a member has limited liability. If the foreign entity has two or more members and at least one member does not have limited liability, the default is to be classified as a partnership. If all of the members of the foreign entity have limited liability, the default is for the entity to be treated as an association and taxable as a corporation. Lastly, if the entity has one single owner, and that owner does not have limited liability with respect to that entity, the entity by default will be a disregarded entity for U.S. taxation purposes.
As such, it is important to analyze the characteristics of the foreign entity to know what default classification it has for U.S. tax purposes, and if the default classification is not desired, an entity classification election needs to be filed.
The decision to file “check the box” election is not a “one size fits all.” Each situation is different, and the implications of making such an election should be completely analyzed prior to moving forward.
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