Choosing Your Entity for U.S. Federal Tax Purposes by Checking the Box

Introduction

U.S. federal tax law provides the taxpayer tremendous flexibility in picking the most tax-effective entity for the taxpayer’s business.  I previously addressed the election to be taxed as an S corporation and created a chart that displays the federal income tax consequences of various Florida business entities.  This article will address other options available for both domestic and foreign entities.

General Overview of Checking the Box

An eligible entity can either choose to maintain its default status for U.S. tax purposes or it may elect to be taxed as another entity.  It may elect to be taxed as another entity by “checking the box,” or selecting their choice of entity on a Form 8832 (Entity Classification Election).  Eligible entities include limited liability companies (“LLCs”) and partnerships.  In general, a corporation is not an eligible entity.

Default Rules

If a Form 8832 is not filed with the Internal Revenue Service (the “IRS”), a domestic eligible entity with two or more members will be classified for U.S. federal tax purposes as a partnership.  The entity will be disregarded as an entity separate from its owners (a “Disregarded Entity”) if it has only one member.   If an entity that is classified as a partnership later has only one member, the entity will be classified as a Disregarded Entity.  A Disregarded Entity with one member will be classified as a partnership if it later has more than one member.

With regard to a foreign eligible entity, if a Form 8832 is not filed with the IRS, and the entity has at least two members, at least one of which does not have limited liability, the entity will be classified for U.S. federal tax purposes as a partnership.  The entity will be taxed as a corporation if all the members have limited liability.  If the entity has a single owner that does not have limited liability, it will be treated as a Disregarded Entity.  Limited liability, for these purposes, occurs if a member has no personal liability for any debts or claims against the entity by reason of being a member of the entity.

What Options Are Available by Checking the Box?

An eligible entity may be:

1)    Taxed as a corporation;

2)    For an entity with two or more members, taxed as a partnership;

3)    For an entity with one member, taxed as a Disregarded Entity.

Timeline for Filing a Form 8832

In general, an election on a Form 8832 will not take effect:

1)    More than 75 days before the date of the filing of the election; and

2)    More than 12 months after the date of the filing of the election.

In certain cases, late election relief may be available.

Limitations on Amounts of Elections

If a newly formed entity makes an election on a Form 8832 and the election was effective on the date of formation of the entity, the entity may again change its classification without any time limitation.  In the case of an entity that made an election that was not effective on the date of the formation of the entity, however, the entity generally cannot change its classification by election for 60 months after the effective date of the election.

In certain cases, the IRS may grant an entity the ability to change its classification within the 60-month period by election.

*This document contains legal information, but does not contain legal advice.

*This document has examined laws in effect in July 2011.