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Late entity classification: IRS guidance

We have often seen clients struggle with their decisions as to what type of tax entity classification they should choose for their businesses. Sometimes business owners or shareholders may decide to change their business’s entity classification after the business has operated for one or more years. These changes may be due to several reasons such as new tax legislation, tax planning, etc. In the past, when we were able to consult with business owners before the year in question ended, we were able to work through these issues and assist in setting up the proper tax entity classification for their businesses on a timely basis.

Unfortunately, in the past, we did not always get the chance to consult with a lot of business owners ahead of time and the deadline to make changes passed for the tax year in question, which meant that the business owner would wait another tax year before making the change. Well, all is not lost. There is a way to make the late change for the current tax year desired even if the deadline was missed. IRS Revenue Procedure 2009-41 (Rev. Proc. 2009-41) may assist these taxpayers to fix what was intended, but not necessarily filed appropriately.

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Rev. Proc. 2009-41 gives guidance to eligible entities on how to obtain relief when making a late entity classification election. The relief is available for three years and 75 days after the requested effective date of the eligible entity’s classification election. This revenue procedure is the only method for obtaining relief for a late entity classification and is in lieu of the letter ruling procedure that is used to obtain relief for the late entity classification election. Also, user fees do not apply to action under this revenue procedure.

Under the check-the-box regulations, a business that is not classified as a corporation can elect, for federal tax purposes, to be treated as an association or a partnership; or if the business has a single member, it can elect to be a disregarded entity. The business makes the election by filing Form 8832, Entity Classification Election, with the IRS Service Center designated on the form. A copy of Form 8832 must also be attached to the federal tax return or information return for the tax year that the business wants to make the election.

The IRS extended the date for entities to make an initial classification election or to change a classification election. To be eligible for the extended late election relief, the business must have failed to timely file Form 8832 and has not filed a federal tax or information return for the first year in which the election was intended because the due date has not passed, or it must have filed all its required federal returns consistent with the classification it intended to obtain.

To make a late election under the provisions of the revenue procedure, an eligible entity must file a completed Form 8832 with the applicable IRS Service Center within three years and 75 days of the effective date of the election along with a statement explaining the reason for its failure to make the election on time. The IRS will notify the entity if it is granting the late election relief.

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Furthermore, there is additional relief for those entities that do not meet the eligibility requirements in the revenue procedure but still want to make an entity reclassification change, they can obtain late election relief through a letter ruling request by including the following representation:

“All required U.S. tax and information returns of the entity (or, if the entity was not required to file any such returns under the desired classification, then all required U.S. tax and information returns of each affected person as defined in Section 4.02 of Rev. Proc. 2009-41) were filed timely or within six months of the due date of the respective return (excluding extensions) as if the entity classification election had been in effect on the requested date. No U.S. tax or information returns were filed inconsistently with those described in the prior sentence.”

Revenue Procedure 2009-41 took effect on September 28, 2009. This revenue procedure will encompass current pending requests and requests made after the effective date.

 

Danette Holguin, EA