Check-the-box: not always the right answer for certain foreign corporations.

• Author: Patelski, Robert

Taxpayers and tax advisers have found the "check the box" rules to provide excellent opportunities for tax planning and tax compliance simplification. Specifically, Sec. 7701 and Kegs. Sec. 301.7701-3 allow individual and corporate owners of corporations meeting limited liability requirements to elect whether to treat the entity as:

1. A taxable corporation;

2. An entity disregarded from its owner; or

3. A partnership, if there is more than one shareholder.

   The check-the-box election gives U.S. shareholders of foreign entities flexibility and certainty. The certainty comes from electing how the entity will be treated for U.S. tax purposes. Flexibility is afforded to shareholders by allowing them to construct an organization that meets the business's tax and economic needs.

   Entity Classification--Use

   The check-the-box election has been particularly useful to U.S. flowthrough entities that have foreign operations. The owners of flowthrough entities (S corporations and partnerships) cannot claim the deemed paid (indirect) tax credit provided by Sec. 902. That is, the taxes paid by the foreign subsidiary are not available for credit to the owners of a flowthrough entity, Creating double taxation. However, when an election is made to treat the foreign subsidiary as a disregarded entity, all of the income and deductions (including foreign taxes) are treated as earned directly by the flowthrough entity. As a result, the foreign taxes are considered direct taxes and are available for credit to the owners.

   The flowthrough election has been a boon to tax planning and has become one of the most commonly used techniques by advisers. However, an often overlooked potential drawback to the election is the loss of the ability to defer income. Multinational companies with a variety of enterprises throughout the world often benefit from being able to align repatriation of income to maximize the use of tax credits and other tax attributes. In a flowthrough environment, other planning steps must be undertaken to meet the organization's needs.

   It is incumbent on tax advisers to examine all the facts and circumstances to ensure that taxpayers' needs are being met. In some situations, taxpayers and their advisers are not in a position to plan for the difficulties of flowthrough income from all sources. Rather, advisers must seek all available opportunities before recommending a check-the-box election.

   An assessment of how the election will affect the taxpayer's...