Revenue procedure attempts to clarify Entity Classification Election.

• Author: Van Leuven, Mary

For federal tax purposes, certain entities can elect pass through tax treatment by simply checking the box. If the entity has one member, it would check to be treated as a disregarded entity; if the entity has more than one member, it would check to be treated as a partnership. As this item points out, checking the box for passthrough treatment is not so simple if the taxpayer is uncertain about whether the entity has more than one member.

If a taxpayer wants passthrough treatment for an entity but is uncertain whether one of the two members of the entity under local law would be considered a member of that entity for federal tax purposes, should the taxpayer file Form 8832, Entity Classification Election, by checking the box for partnership or for disregarded entity? The uncertainty may arise, for example, if a member receives only a fee for services with no other participation in profits and losses, or if a member has such a de minimis interest in the partnership that the IRS may determine that the member should not be treated as a partner. The significance of the issue is the fear that if the wrong box is checked, the election will be invalid (void), and therefore the entity will be classified under its default classification. In the foreign area, this default classification is often corporate status--the classification the taxpayer is trying to avoid.

Rev. Proc. 2010-32

In an effort to address this issue, the IRS issued Rev. Proc. 2010-32 on September 7, 2010. The stated purpose of the revenue procedure is to deal with taxpayer concerns about the validity of entity elections due to the uncertainty regarding the number of owners for federal tax purposes of a foreign entity on the effective date of the election.

If the requirements of the revenue procedure are satisfied, the IRS will treat an election under Regs. Sec. 301.7701-3(c) by a foreign eligible entity to be "a partnership or disregarded entity as an election to be treated as a partnership or disregarded entity (as appropriate) rather than as an association taxable as a corporation."

To qualify to use the revenue procedure, the following requirements must be met:

* The business entity is an eligible entity under Regs. Sec. 301.7701-3(a);

* The business entity is a foreign entity under Regs. Sec. 301.7701-5(a);

* The classification of the business entity (either by default under Regs. Sec. 301.7701-3(b)(2) for a newly formed or newly relevant eligible entity or by election under...