Don't check the box without first checking SALT ramifications.

• Author: McCormick, J. Mark
• Position: State and local tax ramifications

While the Federal "check-the-box" regulations make selecting the type of business entity relatively easy, the state and local tax (SALT) consequences of such a selection can become very complex for multistate taxpayers. Determining the SALT consequences entails much more than determining whether a specific state will follow the Federal check-the-box regulations. An entity's classification can affect whether it may be included in a combined or consolidated state tax return, as well as the resulting apportionment percentage for a given state. (This discussion generally focuses on entities with corporate, rather than individual, owners.)

Federal Check-the-Box Regulations

Under the Federal check-the-box regulations, entities not automatically treated as corporations ("eligible entities") may elect their classification. An entity with more than one owner can elect to be classified as either a corporation or a partnership. An entity with only one owner can elect either to be classified as a corporation or disregarded as an entity separate from its owner (i.e., to be treated as a sole proprietorship, branch or division); certain default rules apply if no election is made. If an eligible domestic entity makes no election, it will be treated as a partnership if it has more than one owner and disregarded if it has only a single owner. If an eligible foreign entity makes no election, it will be treated as a partnership, if it has more than one owner and at least one owner does not have limited liability; as an association, if all owners have limited liability; and disregarded, if it has a single owner that does not have limited liability.

Conformity to Federal Check-the-Box Regulations

The most significant SALT issues associated with the regulations can be narrowed down to state income tax law conformity with the Federal regulations and the state tax treatment of single-member limited liability companies (LLCs). The possibility of differing entity classifications for Federal and state tax purposes creates the potential for both opportunities and unexpected liabilities.

Although the final Federal regulations were issued almost a year ago, fewer than half of the states have formally indicated whether they will follow them.

For business entities with at least two members, most states are expected to follow the check-the-box regulations, either by expressly adopting them or by following existing law that adopts the Code in whole or in part or uses Federal...