Don't even bother to check the box (but you should probably file a form instead.)

• Author: McKinney, Hal, Jr.

On May 9, 1996, the IRS issued Notice PS-43-95, proposing new regulations under Sec. 7701 to simplify the existing entity tax-classification rules. The new proposed regulations follow from hearings last August. The notice announced more hearings on July 20, 1996 (held after this issue went to press). However, as the proposals take a big jump toward simplification, it is instructive to take a look at them now. It is probably best to start with what the proposals do not do. Most of these provisions apply to entities that are outside the mainstream of small business, but they are interesting for perspective.

Entities Still Taxable as Corporations

The proposals list seven kinds of organizations that cannot elect partnership treatment.

1. Business entities formed under Federal, state or Indian tribal statutes as corporations, bodies corporate, bodies politic or incorporated entities.

2. Business entities formed under state statutes as joint-stock companies or associations.

3. Insurance companies taxable under subchapter L.

4. State-chartered banks with Federal deposit insurance.

5. Business entities wholly owned by states.

6. Business entities taxable as corporations under Code sections other than Sec. 7701(a)(3) (e.g., Sec. 7704 publicly traded entities and Sec. 7701(i) taxable mortgage pools).

7. Eighty-plus specific kinds of foreign entities, listed by formation country.

   Note: The new proposals do not affect publicly traded partnerships.

   The foreign entities appearing on the corporate-status list may have some grandfathering relief (discussed later).

   The proposals do not affect most trusts, tenancies-in-common without business operations, state-owned entities integral with state governments, Indian tribes and cost-sharing arrangements under Regs. Sec. 1.482-7.

   Good News for Most Taxpayers

   Entities that do not appear on the corporate-classification list are called "eligible entities." Those with two or more members are eligible to elect partnership tax treatment; single-owner entities are eligible to be taxed as proprietorships. Alternatively, both can choose to be taxed as corporations.

   Perhaps the Best News for Simplification Advocates

   The proposals contain three specific default rules that require no election whatsoever:

1. Nonelecting domestic entities will be taxed as partnerships or proprietorships.

2. Nonelecting but eligible foreign entities with two or more members and at least one member with unlimited liability will be taxed as partnerships.

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