Late Check-the-Box Elections Made Easier

Under Rev. Proc. 2002-15, a new procedure exists to seek relief under Regs. Sec. 301.9100-1 for a late initial-classification election under the Sec. 7701 check-the-box regulations.

Regs. Sec. 301.7701-3 provides that an entity not classified as a corporation under Regs. Sec. 301.7701-2 can choose its tax classification. An entity with multiple owners may choose to be taxed as an association or as a partnership. An entity with only one owner can choose to be taxed as an association or be completely disregarded for tax purposes. Regs. Sec. 301.7701-3(b) provides default classifications, and the check-the-box election overrides the default.

Taxpayers make a check-the-box election under Regs. Sec. 301.7701-3(c)(1) by filing Form 8832, Entity Classification Election, specifying an effective date not more than 75 days before the date that they file the election. If an election specifies an effective date more than 75 days before, the elected classification is effective only 75 days before filing. Thus, the entity is classified under one status for a period of time, and then changed to the other status. For example, assume a foreign entity not on the per se corporation list forms on January 1 and its owners (all of whom have limited liability) intend it to be a partnership, but do not file Form 8832 until June 14. The entity is an association until March 31 at the earliest. On April 1, it changes to a partnership, resulting in a deemed liquidation of the association, followed by a contribution of the assets and liabilities to a partnership (Regs. Sec. 1.7701-3(g)(1)(iii)). Unless the liquidation meets the requirements of Sec. 332, the liquidation is a taxable event.

Regs. Sec. 301.9100-1 gives the Service authority to grant extensions of time to make a regulatory election, if (1) the taxpayer acted reasonably and in good faith and (2) granting the relief does not prejudice the government's interests. Regs. Sec. 301.9100-3(b) lists circumstances under which a taxpayer acts reasonably and in good faith.

Before Rev. Proc. 2002-15, taxpayers had to seek Regs. Sec. 301.9100-3 relief by requesting a letter ruling. The National Office has issued at least 200 rulings for relief for late check-the-box elections since Jan. 1, 1997. The ruling-request process requires the taxpayer to pay an IRS user fee ($6,000 under Rev. Proc. 2002-1), as well as significant fees to attorneys and accountants for their assistance with the request. The process is time-consuming, and the Service may not issue a ruling prior to the time that the taxpayer has to file a tax return or extension request identifying the type of return.

Under the new procedure, taxpayers have to file Form 8832 with the applicable Service center within six months of the original due date for the initial election (or six months and 75 days from the formation of the entity). They must state at the top of Form 8832, "FILED PURSUANT TO REV. PROC. 2002-15." The taxpayer must also attach a statement explaining the reason for the failure to file Form 8832 timely. The IRS then determines whether the taxpayer meets the requirements for grant-ing additional time and notifies the taxpayer of its determination.

An entity would be eligible for this relief if (1) it failed to obtain the desired classification solely because it did not timely file Form 8832; (2) the due date for the tax return of the entity's default classification (excluding extensions) for the tax year beginning with the date of the entity's formation did not pass; and (3) the entity had reasonable cause for its failure to file Form 8832 timely.

It would appear that the factors listed in Regs. Sec. 301.9100-3(b)(1)(ii)(v) as evidence of reasonable action and good faith should also be reasonable cause for not filing Form 8832 timely. The statement explaining the reasons for filing late should emphasize at least one of these factors, but it should also state that evidence of not acting reasonably or in good faith, listed in Regs. Sec. 301.9100-3(b)(3), does not exist. In particular, the Service wants to ensure that the taxpayer does not use hindsight in requesting relief. If specific facts have changed since the original due date of the election that make the election advantageous to the taxpayer, the IRS will not ordinarily grant relief.

If the entity does not meet the requirements for this revenue procedure or the Service Center denies relief, it could still request relief by applying for a letter ruling and paying the attendant user fee.

Rev. Proc. 2002-15 is welcome relief for inadvertent failures to make timely check-the-box elections, providing a corrective procedure without the need to file for a formal letter ruling and pay a user fee.

From Eric Fletcher, CPA, Charlotte, NC