Check-the-box relief for certain foreign entities electing flowthrough treatment. (2024)

The IRS issued Rev. Proc. 2010-32, which provides relief to certainforeign eligible entities that made erroneous entity classificationelections (check-the-box elections) based on a mistaken understanding ofthe number of owners as of the effective date of the election.

In general, when the requirements of Rev. Proc. 2010-32 are met,the IRS will respect the intention of a qualified entity (defined below)to be treated as a flowthrough entity (i.e., as a partnership ordisregarded as an entity separate from its owner (a disregarded entity))rather than treat the qualified entity as an association taxable as acorporation. More specifically, if a qualified entity elected to be apartnership based on the reasonable assumption that it had more than oneowner, but then determined it only had one owner as of the effectivedate of the election, the IRS will treat the original election as anelection to classify the qualified entity as a disregarded entity aslong as the requirements of Rev. Proc. 2010-32 are met. Similarly, if aqualified entity elected to be a disregarded entity based on thereasonable assumption that it had one owner, but then determined it hadmore than one owner as of the effective date of the election, the IRSwill treat the original election as an election to classify thequalified entity as a partnership as long as the requirements of Rev.Proc. 2010-32 are met.

The relief granted by Rev. Proc. 2010-32 is in lieu of the letterruling process ordinarily used to obtain relief for a late change ofentity classification. As such, user fees do not apply to the corrective actions granted under Rev. Proc. 2010-32.

Rev. Proc. 2010-32 is effective on September 7, 2010. Any qualifiedentity that meets the requirements of Rev. Proc. 2010-32 as of September7, 2010, may seek relief pursuant to the revenue procedure.

Definition of "Qualified Entity"

In Rev. Proc. 2010-32, Treasury and the IRS have acknowledgedtaxpayers' concerns regarding the validity of certain check-the-boxelections when a foreign eligible entity elects to be classified as apartnership or as a disregarded entity but has made an error regardingthe number of owners. The concern is a result of the uncertainty thatmay exist regarding the number of owners of a foreign eligible entity onthe effective date of the check-the-box election. To achieve certainty,taxpayers sought permission to file a late election under the letterruling process.

To alleviate these concerns and simplify tax administration, theIRS has indicated that it will treat a check-the-box election underRegs. Sec. 301.7701-3(c) to classify a foreign eligible entity that is aqualified entity as a partnership or disregarded entity as an electionto be treated as a partnership or disregarded entity (as appropriate),rather than as an association taxable as a corporation, if therequirements of Rev. Proc. 2010-32 are met.

In order to avail itself of the relief provided by this revenueprocedure, a business entity must be a "qualified entity."

A business entity is a qualified entity if the following conditionsare satisfied:

1. The business entity is an eligible entity per Regs. Sec.301.770l-3(a);

2. The business entity is a foreign entity per Regs. Sec.301.7701-5(a);

3. The classification of the business entity, either by defaultunder Regs. Sec. 301.770l-3(b)(2)(i)(B) for a newly formed or newlyrelevant eligible entity, or by election under Regs. Sec. 301.7701-3(c)for an existing relevant entity, would be or was an association taxableas a corporation;

4. The business entity filed an otherwise valid Form 8832, EntityClassification Election, electing to be treated for federal tax purposes(per Regs. Sec. 301.77()l-3(c)):

* As a partnership based on the reasonable assumption that it hadtwo or more owners as of the effective date of the election; or

* As a disregarded entity based on the reasonable assumption thatit had a single owner as of the effective date of the election;

5. For federal tax purposes, either:

* The business entity and its actual and purported owners (orowner) have treated the entity consistently with the election on theotherwise valid Form 8832 on all filed information and tax returns; or

* No information or tax returns have been required to be filedsince the effective date for the election made on the otherwise validForm 8832; and

6. The limitation period on assessments (per Sec. 6501(a)) has notended for any tax year of the business entity or its actual andpurported owners (or owner) affected by the election made on theotherwise valid Form 8832.

If a business entity does not qualify for relief under this revenueprocedure, the entity may request relief through the letter rulingprocess in accordance with Rev. Proc. 2010-1 (or its successor).

Process for Obtaining Relief

If a qualified entity files an otherwise valid Form 8832 to beclassified as a partnership for federal tax purposes but it is laterdetermined that the qualified entity had a single owner for federal taxpurposes as of the effective date of the election, the IRS will treatthe Form 8832 as an election to classify the qualified entity as adisregarded entity for federal tax purposes provided that:

* The qualified entity's actual single owner and purportedowners as of the effective date of the election file original or amendedreturns consistent with the appropriate treatment of the entity as adisregarded entity for any tax year that would have been affected if theelection had been made to treat the qualified entity as a disregardedentity for federal tax purposes;

* All required amended returns are filed before the close of thelimitation period on assessments under Sec. 6501(a) for any relevant taxyear; and

* A corrected Form 8832 is filed with the appropriate IRS ServiceCenter and a copy of the corrected Form 8832 is attached to the singleowner's amended return for the tax year during which the originalelection was made as required under Regs. Sec. 301.770t-3(c) (1)(ii).The statement "Filed Pursuant to Revenue Procedure 2010-32"must be written across the top of the corrected Form 8832. The correctedform must also satisfy the requirements of Regs. Sec.301.7701-3(c)(2)(i).

If a qualified entity files an otherwise valid Form 8832 to beclassified as a disregarded entity for federal tax purposes but it islater determined that the qualified entity had two or more owners forfederal tax purposes as of the effective date of the election, the IRSwill treat the Form 8832 as an election to classify the qualified entityas a partnership for federal tax purposes provided that:

* The qualified entity files information returns and its actualowners file original or amended returns consistent with the treatment ofthe entity as a partnership for any tax year that would have beenaffected if the original election had been made to treat the qualifiedentity as a partnership for federal tax purposes;

* All required information and amended returns are filed before theclose of the limitation period on assessments under Sec. 6501(a) for therelevant tax year; and

* A corrected Form 8832 is filed with the appropriate IRS ServiceCenter and a copy of the corrected Form 8832 is attached to theowners' amended returns for the tax year during which the originalelection was made as required under Regs. Sec. 30 1.7701-3(c)(1) (ii).The statement "Filed Pursuant to Revenue Procedure 2010-32"must be written across the top of the corrected Form 8832. The correctedform must also satisfy the requirements of Regs. Sec.301.7701-3(c)(2)(i).

Implications

Rev. Proc. 2010-32 provides welcome relief for taxpayers thatmisidentified the number of owners of foreign eligible entities electingflowthrough status for U.S. federal tax purposes as of the effectivedate of the elections. Taxpayers meeting the requirements of thisrevenue procedure may now avail themselves of this relief process inlieu of requesting relief through the potentially time-consuming letterruling process and paying a user fee. While Rev. Proc. 2010-32 docs notprovide guidance for those taxpayers that have filed for relief underthe letter ruling process and otherwise could seek relief under thisrevenue procedure, such taxpayers might consider withdrawing theirruling requests and seek relief under this revenue procedure. Therevenue procedure, however, does not provide taxpayers with guidanceregarding withdrawing a previously submitted letter ruling request,including the potential for obtaining a refund of user fees uponwithdrawal of the ruling request. In the absence of guidance in Rev.Proc. 2010-32 addressing this issue, it appears that the general rulesdescribed in Section 15 of Rev. Proc. 2010-1 apply, suggesting that theIRS would not refund user fees except in limited circ*mstances.

Taxpayers should also be aware that while Rev. Proc. 2010-32addresses two common errors taxpayers may make when preparing and filingthe Form 8832, the revenue procedure does not address other commontaxpayer errors affecting the validity of a Form 8832, including, forexample, situations in which the signature requirements are notsatisfied on the originally filed Form 8832 or the effective daterequested on the Form 8832 is not the desired effective date. In suchcases, taxpayers should consider whether the Form 8832 as filed issufficient to make a valid election or whether it is advisable tocorrect the errors, including requesting relief under the letter rulingprocess.

Taxpayers should also recognize that Rev. Proc. 2010-32incorporates a reasonableness standard in its scope. The originalelection, although later determined to be erroneous, must have beenbased on a reasonable assumption as to the number of owners as of theeffective date of the election. Presumably, an unreasonable assumptionas to the number of owners would not qualify for relief under thisrevenue procedure. However, the revenue procedure does not define theterm "reasonable," and thus the standard may be a potentialsource of uncertainty in applying the revenue procedure. This may beespecially pertinent where there is no U.S. equivalent or analog to thetype of foreign entity making the election, making it difficult todetermine the number of owners for U.S. federal tax purposes.

The revenue procedure provides guidance only on the classificationof the entities within its scope. Taxpayers should be aware of theincome tax implications of having partnership status rather thandisregarded entity status and vice versa and should consult with theiradvisers concerning such implications.

Taxpayers required to e-file are reminded that amended returns mustalso be e-filed. However, the IRS Modernized eFile (McF) system acceptsonly three tax years at any point. For example, through December 2010,amended returns for tax years 2007-2009 are accepted, and amendedreturns for earlier years must be paper filed. As of January 201 1, taxyear 2007 returns will then have to be paper filed.

Form 1120X, Amended U.S. Corporation Income Tax Return, issubmitted to the MeF by e-filing a Form I 120, U.S. Corporation IncomeTax Return, with the Form 1120X included in the XML file. A copy of thecorrected and signed Form 8832 (including the statement written at thetop described above) that was submitted to the IRS Service Center shouldbe attached as a PDF to the e-filed amended return.

From Julia M. Tonkovich, J.D., L.L.M., Margaret O'Connor,J.D., M.L.T., and Carlos R. Probus, J.D., L.L.M., Washington, DC, andLinda Gurene, CPA, San Antonio, TX