Many businesses and taxpayers find themselves forming foreign corporations, either with the intention of expanding into a global marketplace or, in the case of many of our clients, because they live outside of the United States.
One of the most fundamental decisions to make during this phase is to consider how the foreign entity is treated for US income tax purposes. The “check-a-box” election approach is a popular tool to optimise the tax treatment, so we have put together a brief overview of these regulations.
What is a “check-a-box” election?
A check-the-box election is an election that is made on IRS Form 8832 (Entity Classification Election). The process of making a check-the-box election is relatively straight forward. All you need to do is check the appropriate box, specify the date of the election, and then sign and file the form.
The election allows you to change the tax treatment of an entity from its default position to an alternative. For example, a company that is a corporate entity by default, might electo to be treated as a disregarded entity (if it has one owner) or a partnership (if it has more than one owner). A partnership might elect to be treated as a corporation.
Before you jump into this, be aware that there are many tax implications to consider when making such an election. These implications can be extremely significant so we always recommend speaking to a tax advisor before filing this document.
When is the entity classification election effective?
The election is effective on the date specified on Form 8832. If the date is not specified on the form, then the election is effective from the day that the form was filed. The effective date of the election cannot be:
- more than 75 days before the date the election is filed
- more than 12 months after the date the election is filed
Taxpayers should consider carefully when deciding to check the box on a foreign eligible entity.
The election to treat a company as disregarded entity or partnership results in a deemed disposal by the company of all its assets and a deemed liquidation of the company. As such, where the election does not apply from the date of incorporation this can have significant tax implications.
The check a box election can reap in many benefits. Usually, for our clients these benefits are taking their personal UK company, outside of the various anti avoidance provisions that apply to controlled foreign corporations and onerous information reporting on a tax return. A disregarded entity is effectively charged to tax like sole trader, with reporting on Schedule C and much simpler information return the Form 8858.
Another common situation is in relation to a UK limited liability partnership (LLP). In the US, the default treatment of a UK LLP is as a company (because none of the members has unlimited liability). This can cause numerous tax issues due the US corporate treatment being different to the UK partnership treatment. As such, it would be common to align the treatments by making an entity classification election in the US.
Lastly, the entity classification election can be a useful pre-arrival planning tool for those considering moving to the US, as a means to uplift the basis of non-US assets.
However, in all cases US tax deferral is forfeited in order to achieve the benefits, and so care is needed around mismatches in timing of losses, profits and foreign tax credits.
We highly recommend starting an in-depth evaluation, so that taxpayers can make an informed decision when it comes to making an entity classification regulation.
How can we help?
Here at Ingleton, we can help support and plan the filing process of Entity Classification Elections. The planning procedures before and after the “Check the Box” can be challenging and our professional accountants can guide you seamlessly throughout the process.