Notice 95-14: check-the-box procedure for entity classification.

• Position: Tax Executives Institute International Tax Committee

On July 20, 1995, Tax Executives Institute submitted the following comments to the Internal Revenue Service concerning Notice 95-14, which seeks comments on a proposal proposal to implement a simplified method of entity classification, commonly referred to as a "check-the-box" system. The comments were prepared under theaegis of TEI's International Tax Committee, which is chaired by Philip J. Bergquist of Apple Computer, Inc. Mr. Bergquist testified on the Institute's behalf at a July 20 public hearing on the notice. TEI's comments were developed by a task force that was chaired by Joseph S. Tann, Jr., of Ameritech Corporation and whose members included Harry L. Cox of the Prudential, Melody Johnson of Mission Energy Co., and Lisa Norton of Ingersoll-Rand Co.

On March 29, 1995, the Internal Revenue Service issued Notice 95-14, asking whether a simplified method of classifying unincorporated business organizations should be adopted (commonly referred to as the "check-the-box" system). The notice was published in the INTERNAL REVENUE BULLETIN on March 29, 1995 (1995-14 I.R.B. 7).

Tax Executives Institute is pleased to present these comments on Notice 95-14. Although the notice requests comments on both the domestic and international aspects of the proposal, these comments focus primarily on the Department of Treasury and IRS's authority to issue regulations in this area and on the use of the check-the-box system in the international area. The Institute shall supplement these comments as necessary to address significant domestic issues, as well as to respond to issues raised at the scheduled July 20 hearing on Notice 95-14.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent more than 2,500 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by Notice 95-14, concerning the adoption of a simplified method of entity classification.

Introduction

In Notice 95-14, the IRS and Treasury announced their intention to consider simplifying the existing entity classification regulations to permit taxpayers to elect to treat certain domestic unincorporated business organizations as partnerships or as associations for federal tax purposes. As outlined in the Notice, the election would be available to all such organizations with two or more associates and an objective to carry on business and divide the gain therefrom, unless the organization's classification is determined under a specific provision of the Internal Revenue Code. The affirmative, binding election would be prospective from the date the election is filed or a later date designated in the election. Retroactive elections would not be permitted and the new method would not apply to state-chartered corporations, which would continue to be treated -- and taxed -- as corporations. All partners or shareholders in the entity would be required to agree to the classification election.

TEI commends the IRS and Treasury for proposing a bold, elective approach to resolving the manner in which business entities are classified for tax purposes. Government and taxpayers alike have expended far too many limited resources addressing entity classification issues, and the proposal holds the promise of conserving those resources without undermining any legitimate tax policy goal. More important, it provides an opportunity for clarity, certainty, and simplicity without significant technical compromises or revenue loss. The Institute urges the IRS and Treasury to move swiftly to implement the simplified method in both the domestic and international tax areas as soon as possible.

IRS Rulemaking Authority

TEI is aware that questions have been raised concerning the government's authority to implement a check-the-box system of classification. Although the questions are appropriate ones, we are satisfied that the Government has ample authority to simplify this area by establishing an essentially bright-line, albeit elective, procedure for classifying entities.

The starting point for entity classification is the definitions set forth in section 7701 of the Internal Revenue Code. Section 7701(a)(3) defines the term 'corporation" to include associations, joint-stock companies, and insurance companies, but fails to elaborate on the scope or meaning (or inclusiveness) of those terms. The seminal case in this area is the Supreme Court's 1935 decision in Morrissey V. Commissioner, 296 U.S. 344 (1935), upon which the section 7701 regulations are based. That case did not, however, prescribe the definition of the term "corporation" for federal tax purposes. Rather, it outlined six features of an unincorporated entity (specifically, a trust) that rendered it an "association" and therefore subject to taxation as a corporation.(1)(*) Since the trust at issue in the case possessed all six characteristics, the Court was not obliged to address whether all -- and, if not, how many -- of the characteristics must be present for an entity to be taxable as a-corporation under the Code.(2) Rather, the Court stated that it is within the 'the permissible bounds of administrative construction" for the Treasury to issue rules defining the term "association," and that its regulatory authority was not so restrictive that "the regulations, once issued, could not later be clarified or enlarged so as to meet administrative exigencies or conform to judicial decision." The Morrissey case is therefore not a bar to permitting taxpayers to elect the classification of an unincorporated entity for tax purposes. Indeed, the case...