Entity Classification Election: A Comprehensive Guide to Completing and Submitting Internal Revenue Form 8832

Understanding IRS Form 8832

IRS Form 8832 is a powerful tool that allows a business entity to choose a tax classification of a business entity that is different from the “default classification” assigned to the business entity when it initially obtains an Employer Identification Number (EIN) from the IRS. Many business owners believe that the business entity type they choose at the state level will determine the business entity’s tax classification at the Federal and state level. Luckily, this is not true! Business owners are legally able to mix and match the entity type and tax classification to suit their needs, enhance asset protection, and maximize tax savings. This article will explain how to elect a tax classification that is different from the default classification the IRS will use for your business entity and enhance asset protection and maximize tax savings.

Default Rules

Most people allow the IRS to choose the tax classification of their company based on the IRS’s default rules. Assigning a default tax classification for an entity based on the type of entity “dumbs down” the process of obtaining an EIN (Employer Identification Number) and makes the IRS’s job easier, but there are advantages for the savvy business owner to choosing something different from the IRS’s default classification. The default classification rules for tax classification based on the entity type at the state level are the following:

• State Entity Type: Corporation
  
  • Default IRS Classification: C-Corp
• State Entity Type: Limited Liability Company (LLC):
  
  • Default IRS Classification depends on the number of members:
    
    • One Member: Default IRS Classification: Disregarded Entity
    • Two or more Members: Default IRS Classification: Partnership

Why Not Just Accept the Default Classification Given to You By The IRS?

At the state level, the two common options for business owners are the corporation and the limited liability company (LLC). Corporations are administratively complex with three levels of control, with each requiring robust record keeping to avoid creating opportunities to pierce the corporate veil. Shareholders own the company and appoint directors. Directors develop company strategy, drive the overall direction of the company, and appoint the officers of the company. Officers execute the strategy developed by the directors and make day to day decisions about the company. At each level, detailed records of votes, approvals, and actions should be maintained to ensure the company can definitively establish that it is following all of the processes and procedures laid out in the company’s bylaws.

The corporation structure is fantastic when there are many stakeholders who want to have a voice in who runs the corporation and how the corporation is run. However, because ownership of the corporation by the shareholders is separated from the direction and control of the corporation by the board and officers, it is more likely that an unwanted individual or creditor can take control of the corporation by seizing shares owned by a shareholder.

LLCs on the other hand are less complicated and offer better asset protection because in many cases, the owners are the only ones developing, driving, and executing company strategy. Tighter control by a small group will almost certainly lead to less opportunities for an unwanted individual or creditor to take control of the LLC. In addition, most states give significant deference to the “pick your partner” principles that stop an LLC member from having to proceed with the business venture with a partner who they did not choose. This makes LLCs a superior business entity if you are concerned about protecting your business from falling into the wrong hands. While the legal strength of pick your partner principles varies from state to state, states like Wyoming have firmly embraced the principle by enacting LLC statutes that make a “charging order” against the LLC the exclusive remedy of a member's creditor.

The state level entity types of LLCs and corporations present distinct advantages and disadvantages when it comes to complexity, control, and asset protection. When it comes to tax classification, there are also distinct advantages and disadvantages to having your business entity classified as a disregarded entity, partnership, or C-Corp. Careful consideration of both the entity type and tax classification factors is essential to ensure your business operates in the most efficient and tax efficient manner.

Tax Classifications

C-Corp Tax Classification

Business entities that have either been assigned the default classification of C-Corp (because they are a corporation at the state level) or elected to be treated as a C-Corp by submitting a Form 8832 to the IRS, must file a business tax return on IRS Form 1120 every year. The C-Corp will pay federal taxes at the C-Corp tax rate (21% in 2024) based on the “net income” of the company calculated on Form 1120. Preparing and filing Form 1120 can be time-consuming, but the great thing about C-Corp taxation is that the income does not automatically show up on the owner’s tax return.

The owner will only pay taxes on the salary the C-Corp pays them or on the dividends the owner receives from the C-Corp. The owner’s salary is deducted from the C-Corp’s net income on Form 1120 and is not taxed at both the C-Corp and individual level. However, dividends are subject to double taxation because they are taxed at both the C-Corp level and the individual level. Double taxation is often simplistically portrayed as a bad thing that should be avoided, but when the following are considered, double taxation could actually lead to a lower tax bill:

• C-Corp Federal Tax Rates on Net Income
• C-Corp State Tax Rates on Net Income in State of Formation
• Individual Total Compensation and Income From All Sources
• Individual Earned Income Tax Rates in State of Residency
• Individual Qualified Dividend Tax Rate in State of Residency
• FICA Taxes on Earned Income
• Net Investment Income Taxes on Dividends
• Individual Total Income Needs
• Company Strategy

Partnership Tax Classification

Business entities that have either been assigned the default classification of partnership (because they are an LLC at the state level and have more than one owner) or elected to be treated as partnership by submitting a Form 8832 to the IRS must file a partnership tax return on IRS Form 1065 every year. The partnership will not pay any federal taxes at the partnership level. Instead, the partnership will issue K1s to the owners with details of the company’s net income and the owners will report and be taxed on their share of that income on their individual tax return.

The character of the income will not be changed in this process and the income will “pass through” the Form 1065 partnership return with its original character and tax treatment. For example, if the entity receives qualified dividends, the company will issue a K1 to the owner that lists their share of those dividends. The owner will pay individual taxes on those dividends at their individual tax rate. The single level, pass through taxation of a partnership is easier to calculate but may result in higher taxes for owners of companies with a partnership tax classification when compared to companies with the same net income that have been elected to be treated as C-Corps. Specifically, total aggregate taxes paid by the owner and company may be higher when the owner is a resident of a high tax state and the company operates in a low tax state.

IRS Form 8832

Understanding that you can mix and match the entity type of your company at the state level and the tax classification of your company at the federal level will allow you to optimize your company to achieve the best mix of control, asset protection, and tax efficiency. Deciding on the mix that is best for your company to achieve your goals can be difficult and should probably involve the evaluation, guidance, and advice of a CPA or attorney.

Once you have decided that the default tax classification of your company as determined by the IRS is not the best for you and your company, you will need to change your default tax classification by submitting IRS Form 8832. The rest of this article will guide you on how to prepare and submit IRS Form 8832, so it is accepted by the IRS the first time. While Form 8832 appears to be straightforward, you must be aware that any errors on the submitted form will result in the IRS issuing a CP278 notice to you and your company, denying your request to change the tax classification of your company.

Form 8832 General Concepts

Form 8832 uses language and descriptions that may be unfamiliar to even seasoned CPAs and lawyers. Knowledge of these general concepts will assist you with completing and submitting IRS Form 8832 correctly the first time and avoiding the dreaded CP278 denial of request notice.

• Association: The Internal Revenue Code (IRC) defines an association as any business entity that is not “incorporated” at the state level which nonetheless elects to be taxed as a corporation (C-Corp) at the federal level.
• Corporation: From the IRS perspective, a corporation for federal tax purposes can come in many different forms. The most relevant definitions of a corporation for purposes of preparing and submitting Form 8832 are an entity formed at the state level if the authorizing statute describes the business entity as being incorporated or a being a corporation. Another relevant definition is an association that elects to be taxed as a corporation.
• Disregarded Entity: A business entity with a single owner that is treated as not separate from its individual owner. While not addressed on Form 8832, a business entity with two owners can be treated as a disregarded entity too if the two owners are spouses and the spouses are residents of a community property state. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states. A business owned by a married couple who are residents of one of these states who own the business entity as tenants by the entirety can obtain the default designation of disregarded entity for their company. If you are not sure of the tax classification or your company, you can refer to the CP575 letter issued to your company by the IRS.
• Domestic Eligible Entities: An entity is a company. A domestic entity is a company formed under the laws of a US state or US territory. A domestic entity is eligible (not every entity is eligible to prepare and submit IRS Form 8832) if it is an “association” (not a corporation) that is electing to be treated as a corporation for tax purposes or if it is any type of state level entity that is electing to be treated as anything other than the default classification assigned by the IRS when the entity first obtained its EIN.
• Foreign Eligible Entities. An entity is a company. A foreign entity is a company formed under the laws of another country. A foreign entity is eligible if it has at least one owner that does not have limited liability, electing to be classified as an association taxable as a corporation, or it has a single owner having limited liability, electing to be an entity disregarded as an entity separate from its owner, or it is electing to change its current classification.
• Partnership: A partnership is a business entity that has at least two owners and is not a corporation.

Completing Form 8832: A Step-by-Step Guide

To ensure you complete Form 8832 accurately and avoid a denied submission by the IRS, follow this detailed guide to each numbered section on IRS Form 8832. The guide below assumes you have determined that your company is either a Domestic Eligible Entity or a Foreign Eligible Entity and that you have determined that changing the current tax classification of your business entity is appropriate and will achieve your personal and business goals. You can download IRS Form 8832 from the IRS website, irs.gov, for free:

Eligible Entity Information

At the top of Form 8832, you will enter the name, EIN, and address of your business entity. It is very important that this information exactly matches the information in the IRS files. You should refer to the CP575 letter issued to the company when you initially obtained an EIN for the company, assuming you have not changed the company information by filing IRS Form 8822b since the EIN was obtained.

You may also check one or more of the boxes at the top of the form if you would like to change the address for the company that is on file with the IRS or if you are making a “late” election. Generally, the effective date specified on Form 8832 cannot be more than 75 days prior to the date on which the election is filed and cannot be more than 12 months after the date on which the election is filed. However, if you check one of the late classification boxes, you may be able to make the election effective as much as 3 years and 75 days earlier than the date Form 8832 was submitted. Applying for late classification relief may not be available to your company, and you should speak with a CPA or lawyer before submitting your Form 8832 to avoid a denial of your classification request.

Part I: Election Information

1. Type of Election:
   1. Initial Classification by a Newly-Formed Entity: Check this box if your LLC is newly formed, and you are making the initial election for its federal tax classification. It is unlikely you will check this box because it would require the company to have obtained an EIN without a default tax classification. An EIN is required to submit Form 8832, so it is not clear how your company could have obtained an EIN without a tax classification. In any case, assuming you can check this box, you can skip lines 2a and 2b and proceed directly to line 3.
   2. Change in Current Classification: In most situations, you will check this box. Checking this box will allow you to change the current tax classification of your company. If you check this box you will then proceed to line 2a.
2. Previous Entity Election:
   1. Prior Entity Election: If your LLC has previously filed an entity election within the past 60 months, answer "Yes" and proceed to line 2b. If not, answer "No" and skip line 2b, moving to line 3.
   2. Initial Classification Election: If the prior election was an initial classification election effective on the date of formation, answer "Yes." If not, answer "No" and stop here. You will generally not be eligible to make another election until the 60-month period after the prior election expires.
3. Number of Owners:
   More Than One Owner: If your LLC has more than one owner, you can elect to be classified as either a partnership or an association taxable as a corporation. Skip line 4 and proceed to line 5.
   One Owner: If your LLC has a single owner, you can elect to be classified as an association taxable as a corporation or a disregarded entity. Proceed to line 4.
4. Information for Single Owner LLCs: If the business entity making the election on Form 8832 has only one owner and the owner is an individual, you will provide the name of its owner on line 4a and the owner’s identifying number (social security number, or individual taxpayer identification number) on line 4b. If the business entity making the election on Form 8832 has only one owner and the owner is a business entity AND that one owner entity is a disregarded entity you must identify either the first entity that is not a disregarded entity or the individual who owns the disregarded entity at the top of the entity structure. Effectively, you are telling the IRS where the income from the electing entity will eventually be reported.
   1. Owner's Name: Enter the name of the sole owner of your LLC.
   2. Owner's Identifying Number: Enter the owner's identifying number, which is typically their Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN). If the owner is a foreign person or entity without a U.S. identifying number, enter "none."
5. Information for Affiliated Corporations: This will only apply if the electing entity is owned by a business entity that was either classified as a C-Corp by default or elected to be treated as a C-Corp by filing IRS Form 8832.
   1. Parent Corporation Name: If your LLC is owned by one or more affiliated corporations that file a consolidated return, enter the name of the parent corporation. Again, this only applies if the parent company was either classified as a C-Corp by default or elected to be treated as a C-Corp by filing IRS Form 8832.
   2. Parent Corporation Employer Identification Number: Enter the parent corporation's Employer Identification Number (EIN).
6. Type of Entity: This is the most important part of IRS Form 8832 because it is where you notify the IRS of how you want the tax classification of the business entity to be changed.
   1. A domestic eligible entity electing to be classified as an association taxable as a corporation: Check this box if you are electing your business entity to be classified as an association taxable as a corporation. The business entity would be required to file IRS Form 1120 annually to report and pay taxes on net income.
   2. A domestic eligible entity electing to be classified as a partnership: Check this box if you are electing your business entity to be classified as a partnership. The business entity will be required to file IRS Form 1065 annually and issue K1s to all owners. Remember, this option is not available if your business entity only has one owner. You might choose this option if you initially were the only owner of the business entity, but then you brought on a new partner.
   3. A domestic eligible entity with a single owner electing to be disregarded as a separate entity: Check this box if your single-owner business entity is electing to be disregarded as a separate entity. Remember, this option is not available if your business entity has more than one owner. You might choose this option if you initially had a partner in your business entity, but you bought out the partner, so there is now only one owner.
   4. A foreign eligible entity electing to be classified as an association taxable as a corporation: Check this box if your foreign business entity is electing to be classified as an association taxable as a corporation. This business entity would be required to file IRS Form 1120 annually to report and pay taxes on net income.
   5. A foreign eligible entity electing to be classified as a partnership: Check this box if your foreign business entity is electing to be classified as a partnership. The business entity will be required to file IRS Form 1065 annually and issue K1s to all owners. Remember, this option is not available if your business entity only has one owner.
   6. A foreign eligible entity with a single owner electing to be disregarded as a separate entity: Check this box if your foreign LLC with a single owner is electing to be disregarded as a separate entity. Remember, this option is not available if your business entity has more than one owner.
7. Foreign Country of Organization: If your business entity was created, incorporated, or organized in a foreign jurisdiction, enter the name of the foreign country.
8. Effective Date: Enter the month, day, and year when you want the election to take effect. Remember, the election cannot take effect more than 75 days before the date it is filed, nor can it take effect later than 12 months after the date it is filed unless you are seeking to make a late election and checked the appropriate box at the top of the form
9. Contact Person Information: You should enter the name, title and phone number of the person who understands the information that was entered on Form 8832. The IRS may contact this person to ask them for more information about the submission.

Consent Statement and Signature(s):

This section must be signed by either every member who is an owner at the time the election is filed; or any officer, manager, or member authorized to make the election on behalf of the entity.

By signing, every signatory is declaring under penalties of perjury that they consent to the election and that the information provided is true and accurate. Perjury on an IRS form is considered a federal crime under Title 18 of the United States Code. If you are convicted of perjury, it can result in imprisonment in a federal prison for up to five years and fines of up to $250,000. In addition, if you make an election as a manager or officer and do not actually have the authority to do so, the owners of the company could sue you personally and collect damages from you in the amount of extra taxes they paid based on your unauthorized election. It is critical that you obtain the agreement of the required number of owners (check your operating agreement or bylaws to determine the agreement that is required.) before making an election on Form 8832!

Continuation Sheet: If your company has a lot of owners who must consent to the election, need additional space for signatures or consent statements, attach a continuation sheet with the same information as Form 8832.

Part II: Late Election Relief

11. Explanation for Late Filing: If you are seeking to make an election that will take effect more than 75 days before the date this Form 8832 is filed, or later than 12 months after the date it is filed, you need to explain why you are making the late election and provide “reasonable cause”: for the failure to make the election within the standard election time period. Remember, not every business entity is eligible for late election relief and there are many requirements that will need to be met if the late election is approved. Before making a late election, you should speak with a CPA or lawyer, so you fully understand the process and responsibilities.

Part II of Form 8832 must be signed by an authorized representative of the eligible entity and each "affected person." An affected person is anyone who would have been required to attach a copy of Form 8832 to their federal tax return for the year in which the election was intended to be effective. Because the implications of making a late election can be severe, unlike the signatures on Part I that can be completed by a manager or officer, everyone who will be affected by the election must sign Form 8832.

Eligibility for Electronic Signatures:

During the Covid Pandemic, the IRS temporarily permitted Form 8832 to be submitted with electronic signatures. Prior to that time, Form 8832 required a “wet” signature. Fortunately, the IRS made the temporary change permanent. The IRS will now accept electronic signatures on Form 8832, if the electronic signature meets one of the following acceptable electronic signature methods include:

• Typed Name: Your typed name in a signature block.
• Scanned Signature: A scanned or digitized image of a handwritten signature.
• Electronic Signature Pad: A handwritten signature entered on an electronic signature pad.
• Stylus Input: A handwritten signature, mark, or command entered on a display screen with a stylus device.
• Third-Party Software: A signature created using third-party software.

Submitting Form 8832:

While electronic signatures on Form 8832 are now allowed, you will still need to print the form, prepare an envelope, buy a stamp, and mail the letter to the IRS. The IRS Service Center address to which you must mail the form is determined based on the location of the business entity’s principal business, office, or agency address. The IRS does change the states assigned to each Service Center and the address of the Service Center from time to time. We recommend that you verify the address to which you should mail Form 8832 by reviewing Form 8832 itself.

In addition to mailing the form to the IRS, you must attach a copy of Form 8832 to the business entity’s federal tax or information return for the tax year of the election. Form 1120 is the entity’s tax return and Form 1065 is the entity’s information return. If the entity is not required to file a return for that year, a copy of its Form 8832 must be attached to the federal tax returns of all direct or indirect owners of the entity for the tax year of the owner that includes the date on which the election took effect.

IRS Communication:

After filing Form 8832, the IRS will notify you at the address provided on the form whether your election has been accepted or denied. If the election was approved, you will receive Form CP277 from the IRS. If your election was denied, you will receive the dreaded CP278 from the IRS. In either case, you should generally receive a determination within 60 days of filing. If you do not receive a response from the IRS within 60 days, you can contact the IRS at 1-800-829-0115 or send a letter to the relevant service center.

The Importance of Expert Guidance When Filing Form 8832

Form 8832 is a powerful tool that grants you control over your business entity's federal tax classification. By understanding the questions asked on Form 8832 and meticulously completing each section of the form, you can make informed decisions that align with your business entity’s goals, enhance your asset protection, and minimize your overall tax liability. Remember, consulting with a qualified CPA or attorney is crucial before making any entity classification election. They can help you understand the intricacies of the IRS regulations and navigate the complexities of Form 8832, ensuring you make the best choice for your business entity.