Determination of foreign entity classification in the United States
Heidi Konkel
by Heidi Konkel
As more taxpayers expand operations beyond US borders, it becomes increasingly important to understand how foreign entities formed by those taxpayers are treated for US income tax purposes. Foreign entities may be classified by default as corporations, partnerships, or disregarded entities under US tax law, depending on their legal structure and ownership. This article explores the default classification rules in the US and how to potentially change that classification. Understanding the rules avoids misclassification or failure to file the correct informational returns which can result in significant penalties, often starting at USD 10,000 per form, with additional penalties accruing monthly for continued noncompliance.
Foreign entity default classification for US tax purposes
A foreign entity’s default classification for US tax reporting depends on its ownership structure and liability protections under local law. The IRS maintains a list of “per se” corporations; these entities are automatically treated as corporations for US tax purposes, such as Japan’s Kabushiki Kaisha (KK) or Switzerland’s Aktiengesellschaft (AG). These entities cannot change their classification via election. A full list is available on the Internal Revenue Service (IRS) website in the instructions to Form 8832 Entity Classification Election.
For entities that are not “per se”, classification hinges on liability protections. If any owner has unlimited liability under local law or organisational documents, the entity defaults to either a foreign partnership (multiple owners), or a foreign disregarded entity (single owner). If all owners have limited liability, the default classification is a foreign corporation. For example, a United Kingdom limited company defaults to being treated as a corporation in the US, as its owners typically have limited liability. Conversely, a Canadian unlimited liability company has owners with unlimited liability and defaults to a passthrough entity.
Reporting requirements based on default classification
Once liability obligations are determined, the next step is to determine the ownership structure. An entity with one owner with unlimited liability would be classified as a disregarded entity and required to file Form 8858, Information Return of US Persons with Respect to Foreign Disregarded Entities and Foreign Branches. An entity with more than one owner where one of those owners has unlimited liability would be classified as a partnership and would file Form 8865, Return of US Persons with Respect to Certain Foreign Partnerships. Conversely, for any foreign entity where there is no owner who has unlimited liability or is a “per se” company, the default filing would be Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations.
Change of default classification
Foreign companies that are not “per se” companies can make an entity classification election using Form 8832. This election can significantly affect tax obligations, reporting requirements, and strategic planning.
The election must be filed within 75 calendar days of the intended effective date, and the change must take effect within 12 months of filing. The best practice is to use certified mail for submission. After filing with the IRS, a confirmation letter should be sent to the taxpayer within 60 days and kept in permanent records. When the foreign entity is first included in the US tax return, a signed Form 8832 must be attached to the income tax filing.
If the 75-day deadline is missed, Revenue Procedure 2009-41 allows filing within three years and 75 days, provided the taxpayer has consistently filed as if the election were in place. A reasonable explanation for the delay and signatures under penalties of perjury are required. If this relief is unavailable, a private letter ruling is the only alternative.
Conclusion
Navigating the classification and election process for foreign entities under US tax law is a critical responsibility for tax professionals advising globally active clients. Understanding default classifications, recognising when an entity is eligible to make an election, and adhering to strict timing and procedural requirements are essential to ensuring compliance and avoiding costly penalties.
By proactively analysing entity structures, staying current with IRS guidance, and applying best practices in documentation and filing, practitioners can help clients optimise their tax positions while remaining compliant with US informational reporting obligations. As international operations continue to grow, so too does the importance of getting foreign entity classification right from the start.
Heidi Konkel is a Senior Manager in Wegner CPAs’ tax and business services department. She joined our team with over 20 years of experience in US international tax reporting, compliance, and planning. Heidi has a proven track record in managing complex tax issues for both corporate and individual clients, with a strong focus on federal and state taxation, IC-DISC compliance, and ASC740 tax accounting. Contact Heidi.
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