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Washington Tax Alert March 1, 2011 (classification of foreign entities)

Washington Tax Alert from Don Barnes, dbarnes@washingtontaxlaw.com
March 1, 2011

Business entities organized by U.S. taxpayers in foreign countries, except for certain foreign entities treated as per se corporations, may elect to be treated as corporations or partnerships for Federal income tax purposes if they have two or more owners, or may elect to be treated as corporations or disregarded entities if they have one owner.

Frequently, an entity organized in a foreign country (even if not a per se corporation) will provide all owners with limited liability. In that case, the foreign entity must file a Form 8832 if it wants to be treated as a partnership or disregarded entity for Federal income tax purposes. If a Form 8832 is not filed, the foreign entity will be classified as a corporation for Federal income tax purposes under the default classification rules.

If the foreign entity fails to file a Form 8832, the foreign entity must seek 9100 relief to avoid classification as a corporation under the default rules. This is a common oversight, and the National Office receives scores of these applications. See, e.g., PLR 201108019 (foreign entity that failed to file a Form 8832 requested permission to be treated as a partnership) and PLR 201108007 (foreign entity that failed to file a Form 8832 requested permission to be treated as a disregarded entity).

A related issue arises where the foreign entity files a Form 8832 and elects to be treated as a passthrough entity (either a partnership or a disregarded entity), but incorrectly determines whether it has one or more than one owner for Federal income tax purposes. This can arise because of uncertainties whether an economic interest in the foreign entity is an equity interest, or a debt instrument or the interest of an independent contractor providing services. The National Office recently issued a revenue procedure (Rev. Proc. 2010-32) which grants foreign entities relief where the entity files a Form 8832 electing to be treated as a passthrough entity, but incorrectly determined whether it has one or more than one owner. Where Rev. Proc. 2010-32 applies, the foreign entity is not required to file a 9100 application.