The Check-the-Box Proposal: Simpler Classification for Both Foreign and U.S. Companies

By Kral, Kenneth; Serota, Jack | Journal of Accountancy, September 1996 | Go to article overview

The Check-the-Box Proposal: Simpler Classification for Both Foreign and U.S. Companies


Kral, Kenneth, Serota, Jack, Journal of Accountancy


The Internal Revenue Service has proposed regulations that would replace the current rules for classifying entities as either partnerships or corporations. The proposed regulations would implement the "check-the-box" system in Treasury Department notice 95-14 (1995-1 C.B. 297), allowing an eligible business to choose its classification simply by making the appropriate election on its tax return. The proposed rules would apply for periods beginning on or after publication of the final regulations in the Federal Register.

A complex test

Classification has really ramifications to the owners of an entity--if an entity is classified as a partnership, the income would flow through to the owners, whereas if-it is classified as a corporation, it would be taxed at the entity level. Under the current IRS classification rules, an unincorporated entity's classification is based on whether it exhibits a preponderance of the following corporate characteristics: continuity of life, centralization of management, limited liability, and free transferability of interests. The test is based on the historical differences under state law between partnerships and corporations. The determination requires an analysis of the statutes under which the entity was formed and the governing documents of the entity, such as the articles of association. Currently, all foreign entities are considered unincorporated and therefore potentially subject to this analysis.

Recent changes in state laws, specifically the statutes for limited liability companies (LLCs) and for limited liability partnerships, blur the traditional distinctions between corporations and partnerships and increase the complexity of determining proper classification. It is even more difficult for foreign entities, because they must apply other foreign laws that are very different from U.S. laws.

A simple solution

The IRS has proposed the new check-the-box rules to alleviate these complexities for all eligible entity, defined by the IRS as any business entity that is not required to be treated as a corporation. For domestic companies, a corporation would be any entity formed under a state statute that refers to the entity,T as incorporated or as a corporation and certain other specific types of entities, including most banks. …

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