United States: "Check the Box" Entity Selection – Context for Foreign Entities

1 September 2011
For United States federal income tax purposes, US corporations and foreign entities of the type that can be publicly traded must be treated as corporations. For many other business entities, however, there is an option to elect to be treated either as a corporation or as other than a corporation.

Under IRS regulations regarding entity selection, unincorporated entities such as limited liability companies and partnerships are generally permitted to choose whether they will be treated, for US federal income tax purposes, as partnerships, corporations, or as disregarded entities. The classification of either a US or non-US entity for US tax purposes has no effect for non-US tax purposes.

This entity classification election (referred to as a "check-the-box" election) is made by filing IRS Form 8832, Entity Classification Election. The taxpayer must check the appropriate box, specify the date the election is to be effective, sign and file the form. The entity’s default classification applies if the form is not filed.

For foreign entities, the tax implications of making this type of election can be significant, so we encourage you to seek proper tax planning advice. Depending on the election and the circumstances, foreign tax credit and net operating losses can both pass through to the owner’s US tax return. Under some circumstances, US owners of foreign subsidiaries may benefit from having those entities treated as disregarded entities, as payments between a US owned foreign entity taxed as a corporation and a foreign subsidiary of that entity which has elected itself as a disregarded entity are not treated as Subpart F income. S-corporations (flow-through entities) may also benefit from tax credits. However, there are also disadvantages to changing your entity classification or making an improper election at the outset.

To take best advantage, a check-the-box election should be filed within 75 days of incorporation. It is important to note a request for late election relief is now available within 3 years and 75 days of the date of incorporation (previously a private IRS letter ruling was required). Late election relief (with reasonable cause) is commonly sought by US taxpayers within the first year of the foreign entity’s existence. However, under no circumstance is reclassification possible later than the 60 month limitation rule, and tax ramifications of such a change may be severe.

Eligible entities

It’s important to recognize that only certain entity types can make this election. Under Treasury Regulation § 301.7701-2, certain foreign entities are always classified as corporations for federal tax purposes (so called per se corporations), and they are not eligible to make an entity classification election.

It’s also worth noting that the defaults for eligible domestic and foreign entities differ. A domestic eligible entity which does not file Form 8832 will be classified by default as a partnership if it has two or more members, or disregarded as an entity separate from its owner if it has a single owner. Eligible foreign entities which do not make election on Form 8832 will be classified by default as follows:

  • as a partnership if it has two or more members and at least one member does not have limited liability,
  • as an association taxable as a corporation if all members have limited liability,
  • or disregarded as an entity separate from its owner if it has a single owner that does not have limited liability.

Please contact us to discuss the risks/rewards of “checking the box” when setting up operations in a new country or reclassifying an entity type.