June 1997 | Tax Bulletin

New Check-the-Box Rules Simplify Entity Classification

2 min

For decades, tax practitioners have expended significant time and energy worrying whether an entity (such as limited partnership or limited liability company) would be treated as a corporation (two levels of taxation) or a partnership (one level of taxation) for income tax purposes. Now, the IRS has eliminated most of these worries with final regulations, appropriately called the "check the box regulations," that simply allow certain entities to choose how they want to be taxed.

The new rules divide business entities into three groups: (1) those that are automatically classified as corporations, (2) those that may elect to be classified as partnerships or corporations, and (3) those that may elect to be classified as corporations or be disregarded for tax purposes. The first group includes incorporated entities, insurance companies, banking organizations, state-owned companies, publicly traded partnerships, and certain listed organizations formed outside of the U.S. These entities are not helped by the new rules. Rather, they are automatically classified as corporations.

The second group, entities that may elect partnership or corporate classification, includes all other business entities with at least two members while the third group, entities that may elect to be classified as corporations or be disregarded, includes all business entities not in the group automatically classified as corporations with only a single owner. As a result, entities with two or more owners can avoid double taxation simply by electing to be treated as partnerships. Moreover, although entities with only one owner cannot elect to be partnerships, they can still avoid double taxation by electing to be disregarded. If an entity fails to make an election, certain default rules apply and, absent an affirmative election, the new rules will not affect existing entities.

In summary, the new check-the-box rules are a welcome change from the old complicated classification rules. Indeed, the new rules effectively change entity classification from one of the more complicated areas in the tax law to one of the simplest. This is very good news for all taxpayers!

For more information regarding the new check-the-box rules, please contact Brian J. O'Connor, 410.244.7863 or e-mail BJOConnor@Venable.com.