- 1 Check the Box Election
- 2 Domestic Entities and Check-the-Box-Election Tax Classification Rules
- 3 Domestic LLC (Default) Tax Treatment
- 4 IRC 301.7701-2 Business entities; definitions.
- 5 Foreign Entities and Check-the-Box-Election Tax Classification Rules
- 6 Foreign Per Se Corporation Prevents a Check the Box Election to Reclassify
- 7 International Tax Lawyers Worldwide
Check the Box Election
Check the Box Election for Entity Classification: When it comes to US Tax, the rules involving the IRS classification and taxation rules of entities is much more complicated than taxation of US Person individuals. In general, there are default tax treatment rules which come into effect — depending on the type of entity. For example, when a domestic single member creates a US-based LLC (aka SMLLC), the default tax rule is for the SMLLC be treated as a disregarded entity for tax purposes. If instead, the LLC was created by two members — the default position is that the entity is treated as partnership. In general, there are highly-complex tax laws which impact how the different entity types are treated for tax purposes — along with how complex the tax preparation will be. For example, tax preparation for a single member LLC is usually not much more complicated than including a 1040 Schedule C on the tax return — whereas the bookkeeping and other tax implications of a partnership or corporation are much more complicated. When a Taxpayer wants to, they may be able to modify how the entity is taxed. Let’s go through the basics of the check the box Check-the-Box Election and entity classification tax implications.
Domestic Entities and Check-the-Box-Election Tax Classification Rules
The Check the Box Election refers to how the an entity will be treated for US tax purposes.
As provided by the IRS:
Unless an election is made on Form 8832, a domestic eligible entity is:
- A partnership if it has two or more members.
- Disregarded as an entity separate from its owner if it has a single owner.
- A change in the number of members of an eligible entity classified as an association (defined below) does not affect the entity’s classification. However, an eligible entity classified as a partnership will become a disregarded entity when the entity’s membership is reduced to one member and a disregarded entity will be classified as a partnership when the entity has more than one member.
What does this Mean?
It means that unless the US person takes affirmative steps (Check the Box Election) to change the tax treatment, then a non-corporation association will be treated as a partnership if it has two or more members –it will be treated as disregarded for tax purposes this it is a single member entity — these default rules do not apply to C corporations.
Domestic LLC (Default) Tax Treatment
An LLC refers to a Limited Liability Company — and it is one of the most common types of entities for people starting out with a small business — such as acquiring real estate for rental. The IRS provides the following brief summary regarding the default rules for LLCs:
- A Limited Liability Company (LLC) is an entity created by state statute.
- Depending on elections made by the LLC and the number of members, the IRS will treat an LLC either as a corporation, partnership, or as part of the owner’s tax return (a “disregarded entity”).
- A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation.
- For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and affirmatively elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
What does this Mean?
It means that when it comes to Limited liability Companies, unless an affirmative election is made — then a single-member LLC it is considered a disregarded entity, and if it has two ore more persons and it is considered a partnership. If it is a community property state, then generally the single member LLC disregarded entity rules will apply to the spouses as well.
As provided by the Internal Revenue Service:
Joint Ownership of LLC by Spouse in Community Property States
As provided by the IRS:
Rev. Proc. 2002-69 addressed the issue of classification for an entity that is solely owned by husband and wife as community property under laws of a state, a foreign country or possession of the United States.
If there is a qualified entity owned by a husband and wife as community property owners, and they treat the entity as a:
- Disregarded entity for federal tax purposes, the Internal Revenue Service will accept the position that the entity is disregarded for federal tax purposes.
- Partnership for federal tax purposes, the Internal Revenue Service will accept the position that the entity is partnership for federal tax purposes.
A change in the reporting position will be treated for federal tax purposes as a conversion of the entity.
A business entity is a qualified entity if;
- The business entity is wholly owned by a husband and wife as community property under the laws of a state, a foreign country, or possession of the United States;
- No person other than one or both spouses would be considered an owner for federal tax purposes; and
- The business entity is not treated as a corporation under IRC §301.7701-2.
IRC 301.7701-2 Business entities; definitions.
Is important for Taxpayers to have a baseline understanding of how different entities are defined by law with or without a Check-the-Box-Election.
Here is how certain business entities are defined in accordance with 26 CFR 301.7701-2
(a) Business Entities
- For purposes of this section and § 301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code.
- A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner. But see paragraphs (c)(2)(iii) through (vi) of this section for special rules that apply to an eligible entity that is otherwise disregarded as an entity separate from its owner.
For federal tax purposes, the term corporation means –
- A business entity organized under a Federal or State statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic;
- An association (as determined under § 301.7701-3);
- A business entity organized under a State statute, if the statute describes or refers to the entity as a joint-stock company or joint-stock association;
- An insurance company;
- A State-chartered business entity conducting banking activities, if any of its deposits are insured under the Federal Deposit Insurance Act, as amended, 12 U.S.C. 1811 et seq., or a similar federal statute;
- A business entity wholly owned by a State or any political subdivision thereof, or a business entity wholly owned by a foreign government or any other entity described in § 1.892-2T;
- A business entity that is taxable as a corporation under a provision of the Internal Revenue Code other than section 7701(a)(3); and
- (8) Certain foreign entities – (i) In general. Except as provided in paragraphs (b)(8)(ii) and (d) of this section, the following business entities formed in the following jurisdictions. (See below)
Foreign Entities and Check-the-Box-Election Tax Classification Rules
The default entity classification rules for foreign entities is different for the simple fact that it has to account for all the different countries and all the different entity types — oftentimes which are much different than how entities are established in the U.S.
Foreign Default Rule
Unless an election is made on Form 8832, a foreign eligible entity is:
- A partnership if it has two or more members and at least one member does not have limited liability.
- An association taxable as a corporation if all members have limited liability. Change’s to
- Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability.
What does this Mean?
The default rules for foreign entities are different. In order for a foreign entity to have the default position of being disregarded (which is oftentimes preferred in order to minimize having to file forms such as Form 5471) — the foreign entity must have a single owner that does not have Limited liability. And many foreign countries even single owner entities have some protections which resulted in the single owner having limited liability. This makes it hard for US persons with certain foreign single-member entities to receive disregarded treatment as a default position.
Foreign Per Se Corporation Prevents a Check the Box Election to Reclassify
In addition, in the US government is concerned about work around rules in which a foreign entity may receive beneficial treatment that is should not otherwise be entitled to. Therefore, there are per se rules, in which the US government has determined that the foreign corporation is a per se Corporation.
- American Samoa, Corporation
- Argentina, Sociedad Anonima
- Australia, Public Limited Company
- Austria, Aktiengesellschaft
- Barbados, Limited Company
- Belgium, Societe Anonyme
- Belize, Public Limited Company
- Bolivia, Sociedad Anonima
- Brazil, Sociedade Anonima
- Bulgaria, Aktsionerno Druzhestvo.
- Canada, Corporation and Company
- Chile, Sociedad Anonima
- People’s Republic of China, Gufen Youxian Gongsi
- Republic of China (Taiwan), Ku-fen Yu-hsien Kung-szu
- Colombia, Sociedad Anonima
- Costa Rica, Sociedad Anonima
- Cyprus, Public Limited Company
- Czech Republic, Akciova Spolecnost
- Denmark, Aktieselskab
- Ecuador, Sociedad Anonima or Compania Anonima
- Egypt, Sharikat Al-Mossahamah
- El Salvador, Sociedad Anonima
- Estonia, Aktsiaselts
- European Economic Area/European Union, Societas Europaea
- Finland, Julkinen Osakeyhtio/Publikt Aktiebolag
- France, Societe Anonyme
- Germany, Aktiengesellschaft
- Greece, Anonymos Etairia
- Guam, Corporation
- Guatemala, Sociedad Anonima
- Guyana, Public Limited Company
- Honduras, Sociedad Anonima
- Hong Kong, Public Limited Company
- Hungary, Reszvenytarsasag
- Iceland, Hlutafelag
- India, Public Limited Company
- Indonesia, Perseroan Terbuka
- Ireland, Public Limited Company
- Israel, Public Limited Company
- Italy, Societa per Azioni
- Jamaica, Public Limited Company
- Japan, Kabushiki Kaisha
- Kazakstan, Ashyk Aktsionerlik Kogham
- Republic of Korea, Chusik Hoesa
- Latvia, Akciju Sabiedriba
- Liberia, Corporation
- Liechtenstein, Aktiengesellschaft
- Lithuania, Akcine Bendroves
- Luxembourg, Societe Anonyme
- Malaysia, Berhad
- Malta, Public Limited Company
- Mexico, Sociedad Anonima
- Morocco, Societe Anonyme
- Netherlands, Naamloze Vennootschap
- New Zealand, Limited Company
- Nicaragua, Compania Anonima
- Nigeria, Public Limited Company
- Northern Mariana Islands, Corporation
- Norway, Allment Aksjeselskap
- Pakistan, Public Limited Company
- Panama, Sociedad Anonima
- Paraguay, Sociedad Anonima
- Peru, Sociedad Anonima
- Philippines, Stock Corporation
- Poland, Spolka Akcyjna
- Portugal, Sociedade Anonima
- Puerto Rico, Corporation
- Romania, Societate pe Actiuni
- Russia, Otkrytoye Aktsionernoy Obshchestvo
- Saudi Arabia, Sharikat Al-Mossahamah
- Singapore, Public Limited Company
- Slovak Republic, Akciova Spolocnost
- Slovenia, Delniska Druzba
- South Africa, Public Limited Company
- Spain, Sociedad Anonima
- Surinam, Naamloze Vennootschap
- Sweden, Publika Aktiebolag
- Switzerland, Aktiengesellschaft
- Thailand, Borisat Chamkad (Mahachon)
- Trinidad and Tobago, Limited Company
- Tunisia, Societe Anonyme
- Turkey, Anonim Sirket
- Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu
- United Kingdom, Public Limited Company
- United States Virgin Islands, Corporation
- Uruguay, Sociedad Anonima
- Venezuela, Sociedad Anonima or Compania Anonima
International Tax Lawyers Worldwide
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm for assistance.