Starting January 1, 1997, choosing whether your company will
be taxed as a partnership (the owners are taxable) or a
corporation (the entity is taxable) may be as easy as checking a
box! Say good-bye to the tortuous analysis often used to discern
the differences between corporations and partnerships.
In the past, if a business had any three of four corporate
characteristics -- continuity of life, centralized management,
limited liability or free transferability of interests -- it was
taxed as a corporation. Unfortunately, merely possessing certain
powers, terms and conditions could hand the business a large and
unexpected tax liability.
Businesses required to be taxed as corporations, and thus
ineligible to check the box, include entities incorporated under
specific federal and state statutes, associations treated as
corporations under state law, wholly-owned state organizations,
joint stock companies, insurance companies, banks, publicly
traded partnerships, taxable mortgage pools, and specified
foreign organizations.
The current distinction between a business and a trust (trusts
generally lack an objective to carry on a business and divide
profits, as well as lacking associates) remains intact. The
regulations, however, treat any entity that is not classified as
a trust as a business entity.
Even if an entity may elect to be taxed as either a
corporation or a partnership, not many corporate elections are
anticipated, since corporate taxes are generally more complicated
and expensive.
Any eligible single-owner entity may classify itself as either
an association taxable as a corporation, or be disregarded as a
separate taxable entity (the owner is taxed directly). However,
single-member entities that may be disregarded for federal tax
purposes might not receive identical state tax treatment, unless
that state adopts the federal procedure.
Note: The Franchise Tax Board has announced that since
California law does not automatically incorporate federal
regulations governing entity classifications, the IRS
check-the-box regulations will not apply for state tax purposes.
Expect new legislative action to adopt check-the-box regulations
in California.
If no election is made, default rules apply: A newly formed
domestic entity of two or more members will be classified as a
partnership; and a single-member entity will be regarded as a
sole proprietorship. If an entity is unsure of its status under
the default classification, it should probably file a protective
election.
Certain foreign organizations are required by the IRS to be
taxed as corporations, despite their classifications by the
foreign country. Grandfather rules provide that entities
previously treated as partnerships or disregarded as entities may
continue as such, if they were in existence and not treated as
corporate entities as of May 8, 1996.
With new regulations in effect, entities with limited legal
liability and pass-through tax liability (owners are taxed
directly) -- generally "S" corporations, general
partnerships, limited partnerships and LLCs -- will probably
become the most common business organizations, with the LLC
taking the lead as the favored pass-through entity for family
business planning.
Proposed amendments to state LLC laws would eliminate the
current requirement that, in general, an LLC must dissolve (stop
doing business) either on the withdrawal or death of a member,
thereby allowing the same continuity of life enjoyed by
corporations.
Changes in classification, or converting to a different
business form, may have adverse tax consequences. If an entity
previously classified as an association or corporation elects
partnership tax treatment, the entity and its owners must
recognize any gain generated under the corporate liquidation
rules. Likewise, if an S corporation converts to an LLC, gain on
liquidation is probable.
Usually, transforming a partnership to an LLC is tax-free.
However, converting a partnership to another entity might trigger
taxable income if the partnership's debts and liabilities are
significant and the partner's share of those liabilities is
reduced by the conversion.
Eligible entities choosing not to be classified under the
default rules or desiring to change their previous classification
must file Form 8832 (Entity Classification Election) at the
service center designated on the form. The election must be
signed by each owner or by an authorized person. A copy of the
form must also be attached to the entity's tax return in the year
of the election. The effective date cannot be more than 75 days
prior to the filing date, nor more than 12 months after the
filing date.
Once a business entity selects its classification, it is locked into the classification for 5 years, unless the business is actually transferred to another business. The IRS may waive the 60-month period by a letter ruling, for a more than 50 percent ownership change.
| Home Page | Search | E-mail Form | Firm Profile |
**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**