Check The Box Taxation in the US

Check The Box Taxation in the US

 

An LLC may choose the manner in which it will be taxed.   Since 1997 when the IRS instituted check the box taxation, an LLC may choose to be taxed as a Partnership/Soleproprietorship (depending upon the number of members), an S-Corporation or a C-Corporation.

This flexibility to choose the LLC's manner of Federal Tax (and most states allow the LLC to be taxed in the same manner it is taxed Federally) is called "Check The Box Taxation".  Even though the default manner of tax for the LLC is Flow through, there are other options.  For the majority of LLCs, flow through taxation is preferable.  It is best to understand your options however, because there are times when the other two are very useful.

In short, a "check-the-box" election is an entity classification election that is made on I.R.S. Form 8832, Entity Classification Election.  The procedure to make a check-the-box election is quite easy.  You simply check the appropriate box, specify the date that the election is to be effective, sign and file the form.

Be aware, however, that the tax implications of making such an election can be extremely significant.  It is therefore very important that taxpayers speak with a tax adviser to discuss the implications of making such an election before the election is made.

Only "eligible entities" can make check-the-box elections.  The regulations contain a list of the types of entities that are not eligible entities.  Treas. Reg. § 301.7701-2(b).  These non-eligible entities must be treated as corporations and are often referred to as "per se" corporations.

In the domestic context, an entity organized as a "corporation" or as "incorporated" under a federal or state statute would be a per se corporation.  For foreign entities, a country-by-country list is provided in the regulations that specifies the per se corporations for each country.  Typically, S.A.s, N.V.s, P.L.C.s, and A.G.s are per se corporations.

Tax Classifications

There are three possible U.S. tax classifications for "business entities" --- corporation, partnership, or disregarded entity.  The regulations provide default classification rules for eligible entities (i.e., non-per se corporations) that do not make check-the-box elections.  Treas. Reg. § 301.7701-3(b).

A U.S. domestic "eligible entity" defaults to be treated as a partnership if the entity has more than one owner and as a disregarded entity (similar to a sole proprietorship for individuals or to a branch or a division for corporations) if the entity has only one owner.

 

The default classification rule for non-U.S. entities is different.  It is often assumed by taxpayers and their domestic tax advisers that a foreign entity that is similar to a U.S. L.L.C. will default to be treated as a partnership or disregarded entity (as would be the case for a U.S. L.L.C.).  However, foreign L.L.C.s almost always default to be treated as corporations.

The rule for a foreign eligible entity is that it will default to be treated as:

1. a corporation if all of its owners have limited liability,
2. a partnership if it has two or more owners and at least one owner does not have limited liability, and
3. a disregarded entity if it has a single owner that does not have limited liability.

Check the box for non-US entities

 

Regarding check the Box for non-US Entities, both the foreign tax credit and operating losses pass through to the owners American tax return.  The single member foreign entity has simplified his/her reporting as compared for a controlled foreign corporation.

Foreign entities that qualify for the check the box rules are great for foreign tax credit planning and the pass through of operating loss.  To avoid complex tax issues, the check the box election is best filed in the first year of existence of the foreign entity.

We have found an IRS email private letter rulings on  an LLC owned in a community property state.  If you are a tax planner, this PLR gives great advice.

Check the Box is a great tax planning tool for international taxation, if you know where it is taking you.  When the checks the box election is filed for a foreign entity, what occurs in a community property state.    A major tax difference exists between a foreign partnership and a disregarded entity.

According to the IRS " the election under Rev. Proc. 2002-69 is optional. If no election is made, then the classification of the LLC defaults to the "check the box" regulations, Treas. Reg. § 301.7701-3. Under these regulations, if there are two owners of the business, it is automatically by default a partnership. If there is one owner of the business, it is automatically by default a disregarded entity.

The election and default rules under Rev. Proc. 2002-69 supersede the governing documents. Therefore, while both husband and wife appear as responsible individuals on the governing documents, which would imply a partnership, they can elect to have their business considered a disregarded entity. Since no returns have been filed and the husband and wife have not made an election under Rev. Proc. 2002-69, the business would be considered a partnership because both husband and wife own the business."

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