When it comes to international tax compliance, the US is a sought after tax haven for non-US Taxpayers. Money just tends to quietly flow into the USA—ALL THE TIME!

For non-US taxpayers the line is blurred at best between ‘investing’ in the US and ‘sheltering’ assets from foreign taxation by ‘hiding’ those assets in the US. This is a direct result IMHO of the seemingly random and varied Limited Liability Company (LLC) regulations governed at the state level and taxed at the federal level.

Wyoming, Nevada, South Dakota—HA! Don’t even get me started. Some states are consumer friendly; others are investor friendly. Most simply want you to register if you have the prospects of a viable operation.

Sheltering v. investing aside, I’ve leaned in just far enough to KNOW from a US federal income tax perspective that a foreign taxpayer’s entity classification spelled out in Regulations section 301.7701 and IRM 4.61.5 can be a huge decision.

In many instances, it necessitates filing IRS Form 8832 – Entity Classification Election. However, if you are willing to accept the default entity classification rules, IRS Form 8832 is not necessarily required.

The 3 default rules that are used to define your organization’s entity classification for US income tax purposes are generally speaking the existing entity default rule, the domestic entity default rule, and the foreign entity default rule.

Existing Entity Default Rule – 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.

Domestic Entity Default Rule – A domestic eligible entity is a partnership if it has two or more members or disregarded as an entity separate from its owner if it has a single owner.

Foreign Entity Default Rule – A foreign eligible entity is a partnership if it has two or more members and at least one member does not have limited liability. It can also be an association taxable as a corporation if all members have limited liability. Or it can be ‘disregarded’ as an entity if it has a single owner that does not have limited liability.

If you’ve made it this far into the post salute yourself. Most people it seems simply tend to accept the above default entity classification rules unwittingly or otherwise and roll with it.

Those foreign qualified entities that are diligent and careful tend to file IRS Form 8832 to classify themselves as a partnership or or other ‘disregarded’ entity for US federal income tax purposes. Others tend to elect to be treated as an association taxable as a corporation.

This is where ‘investing’ can blur into ‘sheltering’ for those reprobates among us unconcerned about an afterlife. Either way, if you do file the 8832 form, there are six eligible entity selections to chose from.

1. A domestic eligible entity electing to be classified as an association taxable as a corporation.

2. A domestic eligible entity electing to be classified as a partnership.

3. A domestic eligible entity with a single owner electing to be disregarded as a separate entity.

4. A foreign eligible entity electing to be classified as an association taxable as a corporation.

5. A foreign eligible entity electing to be classified as a partnership.
6. A foreign eligible entity with a single owner electing to be disregarded as a separate entity.
Generally, corporations are not eligible entities unless the entity elected to be an association taxable as a corporation. Understanding the income tax implications of each is important.

There are other nuances spelled out in Rev. Proc. 2009-41 & Rev. Proc. 2010-32 to familiarize yourself with including filing a late election as well as residual effects of the Election.

Pay particular attention to deemed contributions & distributions, including:

-If an eligible entity classified as a partnership elects to be classified as an association, it is deemed that the partnership contributes all of its assets and liabilities to the association in exchange for stock in the association, and immediately thereafter, the partnership liquidates by distributing the stock of the association to its partners.

-If an eligible entity classified as an association elects to be classified as a partnership, it is deemed that the association distributes all of its assets and liabilities to its shareholders in liquidation of the association, and immediately thereafter, the shareholders contribute all of the distributed assets and liabilities to a newly formed partnership.

-If an eligible entity classified as an association elects to be disregarded as an entity separate from its owner, it is deemed that the association distributes all of its assets and liabilities to its single owner in liquidation of the association.

-If an eligible entity that is disregarded as an entity separate from its owner elects to be classified as an association, the owner of the eligible entity is deemed to have contributed all of the assets and liabilities of the entity to the association in exchange for the stock of the association.

Top 10 Administrative And Procedural Lessons Learned

 

1. Generally, an election specifying an eligible entity’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An eligible entity can obtain a late election relief in certain circumstances.

2. Attach a copy of Form 8832 to your entity’s federal tax or information return for the tax year of the election. If the entity is not required to file a return for that year, a copy of its Form 8832 must be attached to the federal tax returns of all direct or indirect owners of the entity for the tax year of the owner that includes the date on which the election took effect.

3. An indirect owner of the electing entity does not have to attach a copy of the Form 8832 to its tax return if an entity in which it has an interest is already filing a copy of the Form 8832 with its return.

4. Failure to attach a copy of Form 8832 will not invalidate an otherwise valid election, but penalties may be assessed against persons who are required to, but do not, attach Form 8832. Each member of the entity is required to file the member’s return consistent with the entity election. Penalties apply to returns filed inconsistent with the entity’s election.

5. Care should be exercised to ensure that the IRS receives the election. If your entity is not notified of acceptance or nonacceptance of its election within 60 days of the date of filing, call 1-800-829-0115, or send a letter to the service center to inquire about its status.

6. Send all correspondence by certified or registered mail via the U.S. Postal Service, or equivalent type of delivery by a designated private delivery service.

7. Regarding Employer Information Number (EIN) – do NOT put “Applied For” on this line. Any entity that has an EIN will retain that EIN even if its federal tax classification changes under Regulations section 301.7701-3. If a disregarded entity’s classification changes so that it becomes recognized as a partnership or association for federal tax purposes, and that entity had an EIN, then the entity must continue to use that EIN. If the entity did not already have its own EIN, then the entity must apply for an EIN and not use the identifying number of the single owner.

8. A foreign entity that makes an election under Regulations section 301.7701-3(c) and (d) must also use its own taxpayer identifying number. If the entity electing to be classified using Form 8832 does not have an EIN, it must apply for one on Form SS-4, Application for Employer Identification Number.

9. The entity must have received an EIN by the time Form 8832 is filed in order for the form to be processed. An election will not be accepted if the eligible entity does not provide an EIN.

10. Do not apply for a new EIN for an existing entity changing its classification if the entity already has an EIN.

Limited Liability Versus Personal Liability From An IRS Perspective

 

Limited liability exists if as a member of the entity you have no personal liability for any debts of or claims against the entity by reason of being a member based solely on the statute or law under which the entity is organized as well as organizational documents.

Personal liability exists if the creditors of the entity may seek satisfaction of all or any part of the debts or claims against the entity from you personally as a member of the entity. You have personal liability even if you make an agreement whereby someone else assumes that liability or agrees to indemnify you from liability.

Consider Filing the Election If Your Entity Is One Of The Following:

 

-A domestic entity electing to be classified as an association taxable as a corporation.

-A domestic entity electing to change classification (even if it is currently classified under the default rule).

-A foreign entity, more than one owner, all owners having limited liability, electing to be classified as a partnership.

-A foreign entity that has at least one owner that does not have limited liability, electing to be classified as an association taxable as a corporation.

-A foreign entity with a single owner having limited liability, electing to be an entity disregarded as an entity separate from its owner.

-A foreign entity changing classification (even if it is currently classified under the default rule).

-Do not file this form for an eligible entity that is either Tax-exempt under IRC 501(a); or a real estate investment trust (REIT), under IRC 856; or is Electing to be classified as an S corporation.
-An eligible entity that timely files Form 2553 to elect classification as an S corporation and meets all other requirements to qualify as an S corporation is deemed to have made an election under Regulations section 301.7701-3(c)(v) to be classified as an association taxable as a corporation.