For United States income tax purposes, a business entity may elect to be treated either as a corporation or as other than a corporation.26 CFR 301.7701-2 and 301.7701-3 , Boris Bittker & James Eustice, Federal Income Taxation of Corporations and Shareholders, abridged paperback , chapter 2. This entity classification election is made by filing Internal Revenue Service Form 8832. Absent filing the form, a default classification applies. U.S. corporations of the type that can be publicly traded must be treated as corporations. There is a list of specific foreign entities that must be treated as corporations.26 CFR 301.7701-2(b)(8)(i) The election is effective for Federal income tax purposes.
If an entity is not classified as a corporation, it is treated as a partnership for U.S. tax purposes if it has more than one owner, or is treated as a "disregarded entity" if it has a single owner (i.e. is treated as part of the single owner).
The classification of either a U.S. or non-U.S. entity for U.S. tax purposes has no effect for purposes other than U.S. income tax.
Eligibility to make an election An entity, which is eligible to make an election, is referred to as an eligible entity. Generally, a corporation organized under U.S. federal or state statute (and referred to as a corporation, body corporate or body politic by that statute) is not an eligible entity. However, the following types of business entity are treated as eligible entities: An eligible entity that previously elected to be an association taxable as a corporation by filing Form 8832. An entity that elects to be classified as a corporation by filing Form 8832 can make another election to change its classification, subject to the 60-month limitation rule. A foreign eligible entity that became an association taxable as a corporation under the foreign default rule described below. A foreign corporation that is not identified as a corporation under Treasury regulations §301.7701-2(b)(8). If a foreign corporation is not identified on the list included in these regulations, it qualifies as an eligible entity.
The list of foreign entities classified as corporations for federal tax purposes (so called per se corporations, not eligible to make an entity classification election) includes, as of September 2009:Treasury regulations §301.7701-2 (b)(8); latest amendment T.D. 9462, 74 FR 46904, Sept. 14, 2009
American Samoa, Corporation Argentina, Sociedad Anónima Australia, Public Limited Company Austria, Aktiengesellschaft Barbados, Limited Company Belgium, Naamloze Vennootschap/Société Anonyme/Aktiengesellschaft Belize, Public Limited Company Bolivia, Sociedad Anónima Brazil, Sociedade Anónima Bulgaria, Aktsionerno Druzhestvo. Canada, Corporation and Company Chile, Sociedad Anónima People's Republic of China, Gufen Youxian Gongsi Republic of China (Taiwan), Ku-fen Yu-hsien Kung-szu Colombia, Sociedad Anónima Costa Rica, Sociedad Anónima Cyprus, Public Limited Company Czech Republic, akciová společnost (or a.s. or akc. spol.) Denmark, Aktieselskab Ecuador, Sociedad Anónima or Compañía Anónima Egypt, Sharikat Al-Mossahamah El Salvador, Sociedad Anónima Estonia, Aktsiaselts European Economic Area/European Union, Societas Europaea Finland, Julkinen Osakeyhtio/Publikt Aktiebolag France, Société anonyme Germany, Aktiengesellschaft Greece, Anonymos Etairia Guam, Corporation Guatemala, Sociedad Anónima Guyana, Public Limited Company Honduras, Sociedad Anónima 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, Società per Azioni Jamaica, Public Limited Company Japan, Kabushiki Kaisha (kabushiki gaisha) Kazakhstan, Ashyk Aktsionerlik Kogham Republic of Korea, Chusik Hoesa Latvia, Akciju sabiedrība Liberia, Corporation Liechtenstein, Aktiengesellschaft Lithuania, Akcine Bendrove Luxembourg, Société anonyme Malaysia, Berhad Malta, Public Limited Company Mexico, Sociedad Anónima Morocco, Société anonyme Netherlands, Naamloze Vennootschap New Zealand, Limited Company Nicaragua, Compañía Anónima Nigeria, Public Limited Company Northern Mariana Islands, Corporation Norway, Allment Aksjeselskap Pakistan, Public Limited Company Panama, Sociedad Anónima Paraguay, Sociedad Anónima Peru, Sociedad Anónima Philippines, Stock Corporation Poland, Spolka Akcyjna Portugal, Sociedade Anónima Puerto Rico, Corporation Romania, Societate pe Actiuni Russia, Otkrytoye Aktsionernoy Obshchestvo (Открытое акционерное общество) Saudi Arabia, Sharikat Al-Mossahamah Singapore, Public Limited Company Slovak Republic, Akciova Spolocnost Slovenia, Delniska Druzba South Africa, Public Limited Company Spain, Sociedad Anónima Surinam, Naamloze Vennootschap Sweden, Publika Aktiebolag Switzerland, Aktiengesellschaft Thailand, Borisat Chamkad (Mahachon) Trinidad and Tobago, Limited Company Tunisia, Société anonyme Turkey, Anonym Şirket Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu United Kingdom, Public Limited Company United States Virgin Islands, Corporation Uruguay, Sociedad Anónima Venezuela, Sociedad Anónima or Compañía Anónima
In 2013, the IRS added a Croatian to the list of per se corporations.Notice 2013-44
Default classification An eligible entity is classified for federal tax purposes under the default rules described below unless it files Form 8832 or Form 2553, Election by a Small Business Corporation, to elect a classification or change its current classification. The IRS uses the information entered on the form to establish the entity's filing and reporting requirements for federal tax purposes.IRS Form 8832: Entity Classification Election Certain domestic and foreign entities that were in existence before January 1, 1997, and have an established federal tax classification generally do not need to make an election to continue that classification. If an existing entity decides to change its classification, it may do so subject to the 60-month limitation rule.Treasury regulations §301.7701-3 (b)(3) and (h)(2).
Unless an election is made on Form 8832, a domestic eligible entity will be classified by default as: 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.
Unless an election is made on Form 8832, a foreign eligible entity will be classified by default as: 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. Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability.
The effect of these rules is that a U.S. limited liability company (LLC) or limited liability partnership (LLP) is treated by default as a partnership (or disregarded entity if it has only one owner), whereas a foreign LLP is treated by default as a corporation (if, as is generally the case, all its members have limited liability).
If an entity has been operating under one classification for some time, but then elects to change its classification, there may be tax consequences. The initial regulations were unclear on this point, so the IRS issued Revenue Rulings 99-5 and 99–6 in 1999 to address questions surrounding the conversion of an LLC to a partnership and vice versa.Clarifying Entity Classification Conversions , Steven M. Friedman & Samuel H. Hoppe, Commercial Investment Real Estate Magazine, July/August 1999.
Use in international tax planning The "check-the-box" regulations paved the way for various new tax avoidance and tax deferral strategies.Analyzing Subpart F in light of Check-the-Box, Cynthia Ram Sweitzer, Akron Tax Journal 20, March 2005. See pp. 9-11, 23 Specifically, they expanded the opportunity for "hybrid branch" or "hybrid entity" strategies, which take advantage of differences in the classification of an entity as a corporation or not in multiple jurisdictions, in order to engage in cross-border tax arbitrage. The possibility that the check-the-box rules would greatly expand the potential for such strategies had been pointed out prior to implementation, and at one point some commentators suggested disallowing foreign entities from electing their classification at all; however, in the end, the IRS, while acknowledging such concerns, issued regulations which gave foreign and domestic entities largely similar powers to elect their own classification.
US owners of foreign subsidiaries benefit from the ability to have those foreign subsidiaries treated as disregarded entities. Under the United States' Internal Revenue Code Subpart F, payments between related Controlled Foreign Corporations (CFCs), or from American companies to related CFCs, may be "treated as Subpart F income" (subject to current taxation as if they were profits in the hands of the ultimate American owner of the corporate structure), in an effort to limit the ability of American citizens and corporations to defer US tax on the income of foreign corporations they control. However, payments between an American-owned foreign entity which is taxed as a corporation, and a foreign subsidiary of that entity which itself has elected to be treated as a disregarded entity, are not treated as Subpart F income.'Unchecking the Box' Could Lead to Fierce Debate, CFO Magazine, May 11, 2009 This arrangement may be used to shift income between the two non-American jurisdictions and avoid local taxes in one or the other, e.g. through thin capitalization. Another category of US taxpayers who benefit from check-the-box regulations consists of US flow-through entities (S corporations and partnerships) with foreign subsidiaries. If the foreign subsidiary is treated as a corporation, the taxes it pays to the foreign government do not create a foreign tax credit for the US owner under Section 902. However, with a check-the-box election to be treated as a disregarded entity, the foreign taxes are treated as having been directly imposed on the US owner, thus giving rise to the tax credit."Check-the-Box: Not Always the Right Answer for Certain Foreign Corporations". Robert Patelski, The Tax Adviser 37(4), April 2006.
For US owners with foreign subsidiaries, choosing to have a subsidiary treated as a disregarded entity is not always the most beneficial tax-planning choice, however. For example, if a US taxpayer owns a disregarded foreign entity, its income will be taxed at the owner's ordinary US income tax rates, less the foreign tax already paid. This may result in every marginal dollar being taxed at the highest rate. However, if the foreign entity had elected to be taxed as a corporation (or been classified as such by default), paid a low rate tax in the foreign country, then repatriated its income to the US by paying qualified dividends to its owner, the total proportion of tax paid on income might actually be less, as qualified dividends are only taxed at 15%. However, this treatment is only available for dividends from corporations in certain countries, and is set to sunset in 2010 under the Tax Increase Prevention and Reconciliation Act of 2005.