Clients frequently reach out on consultations to understand the taxation, liability, and reporting requirements related to entity structuring. For federal tax purposes, LLCs and foreign entities taxed in the US can choose their classification by filing Form 8832, Entity Classification Election. Much can be done to optimize tax positions by filing this form. However, when an entity fails to file this election on time, it may be subject to default classification rules that might not create the optimal tax position for the company or reflect how the owners intended to conduct the business.

To provide relief for late elections, the IRS issued Revenue Procedure 2009-41, which allows certain entities to make a late entity classification election within three years and 75 days of the requested effective date, provided they meet specific criteria. Additionally, Revenue Procedure 2010-32 further clarified entity classification concerns, particularly for foreign entities.

Entity Classification and Default Rules

Under Treasury Regulations, a business entity that is not classified as a per se corporation (an “eligible entity”) can elect its classification for tax purposes. The classification options include:

• For entities with two or more members:
• Partnership (default classification)
• Association taxable as a corporation (by election)
• For entities with a single owner:
• Disregarded entity (default classification)
• Association taxable as a corporation (by election)

If an eligible entity does not file Form 8832 to specify its classification, default rules apply:

• A domestic eligible entity is classified as:
• A partnership if it has two or more members
• A disregarded entity if it has a single owner
• A foreign eligible entity is classified as:
• A partnership if it has two or more members, and at least one does not have limited liability
• A corporation if all members have limited liability
• A disregarded entity if it has a single owner who does not have limited liability

Why Late Elections Are a Concern

Many businesses fail to file a timely entity classification election due to administrative oversight, miscommunication, or misunderstanding of the IRS rules. If an entity is classified under default rules, it could result in unintended tax consequences, such as:

• Being taxed as a corporation when it intended to be a partnership or disregarded entity
• Losing passthrough tax treatment, leading to double taxation
• Facing IRS penalties and compliance issues

To address these concerns, the IRS provides late election relief under Revenue Procedure 2009-41 for entities that can demonstrate reasonable cause for failing to file on time.

Relief Under Revenue Procedure 2009-41

Issued on September 28, 2009, Rev. Proc. 2009-41 supersedes Rev. Proc. 2002-59 and extends relief for both initial classification elections and changes in classification. It allows an entity to retroactively elect a classification within three years and 75 days from the intended effective date, provided the entity meets the eligibility requirements.

Eligibility for Late Election Relief

An entity qualifies for relief under Rev. Proc. 2009-41 if it meets the following conditions:

1. Failure to File on Time

• The entity did not obtain its requested classification solely because Form 8832 was not filed timely.

1. Consistency in Tax Reporting

• One of the following conditions must be met:
  • The entity has not yet filed a tax return for the first year in which the election was intended, OR
  • The entity has timely filed all required tax returns consistent with the requested classification.
• If an entity is not required to file tax returns, all affected owners must have filed consistent tax returns with the intended classification.

1. Reasonable Cause

• The entity must provide a valid reason for failing to file on time.

1. Filing Within Three Years and 75 Days

• The late election must be made within three years and 75 days from the requested effective date.

If an entity does not meet these criteria, it may still seek relief by requesting a letter ruling from the IRS.

Procedural Requirements for Late Election Relief

To obtain relief under Rev. Proc. 2009-41, the entity must:

• File a completed Form 8832 with the IRS
• Indicate that it is being filed pursuant to Rev. Proc. 2009-41
• Include a declaration explaining the reason for the late filing
• Sign the declaration under penalty of perjury

By following these steps, the IRS may grant retroactive classification relief, allowing the entity to be taxed as intended.

Special Considerations for Foreign Entities: Revenue Procedure 2010-32

For foreign entities, entity classification can be more complex, particularly when there is uncertainty about the number of members. If a foreign entity mistakenly elects partnership or disregarded entity treatment, it may default to corporate status, which can lead to unexpected tax consequences.

To address this issue, the IRS issued Revenue Procedure 2010-32, which provides relief in cases where:

• The entity reasonably assumed it had two or more owners (electing partnership status) or a single owner (electing disregarded entity status)
• The entity and its owners consistently filed tax returns based on the intended classification
• The IRS statute of limitations has not expired for any tax year affected by the election

If the above conditions are met, the IRS will treat the erroneous election as valid and allow the entity to correct its classification without adverse consequences.

How to Correct an Erroneous Foreign Entity Election

Entities qualifying for Rev. Proc. 2010-32 must:

• File amended tax returns consistent with the correct classification
• Submit a corrected Form 8832
• Ensure all filings are completed before the IRS statute of limitations expires

Entities that do not qualify under this procedure may seek relief through a letter ruling from the IRS.

Late Entity Election Takeaways:

1. Entity classification elections are essential for tax efficiency and legal clarity. Default rules may not always align with business objectives.
2. Rev. Proc. 2009-41 provides relief for entities that failed to file Form 8832 on time, extending the deadline to three years and 75 days from the requested effective date.
3. To qualify for late election relief, an entity must demonstrate reasonable cause and consistent tax reporting with the intended classification.
4. Foreign entities face unique challenges, and Rev. Proc. 2010-32 provides relief for businesses that incorrectly assumed their membership structure.
5. Entities that do not meet the standard relief criteria may request a private letter ruling from the IRS.

If your business needs assistance with late entity classification elections, consulting a tax professional can help ensure compliance and minimize risks. Proper tax planning can prevent costly classification errors and optimize tax treatment for your business. Please reach out to our team if you need help or schedule a consultation today.