The entity classification regulations, commonly known as the "check-the-box" regulations, allow certain entities known as "eligible entities" to choose how they would like to be considered for U.S. federal tax purposes. For example, corporation, partnership, or disregarded entity. This flexibility can allow some advantages, both domestically and internationally, such as:

  • When a non-corporate status is required for U.S. tax purposes, switching an entity to a partnership or disregarded entity without having to eliminate the entity under local laws.
  • Steering clear of the anti-deferral rules that pertain only to foreign corporations under Controlled Foreign Corporation (CFC) and Passive Foreign Investment Companies (PFIC)

When considering a check-the-box election, something additional needs to be considered for foreign entities – and that is "relevance." Essentially, a foreign eligible entity's classification is "relevant" when that classification affects the legal responsibility of any person for U.S. federal tax purposes. For example, an entity's classification is relevant when the amount of withholding on an item of U.S. income is paid to a foreign entity and varies depending on whether that entity was classified as a partnership or as a corporation.

With check-the-box regulations, it’s important to know the difference between an election that produces a "change in classification" and an election that produces an "initial classification." A “change in classification” means that an entity has decided to change the way it was previously classified under the entity classification rules. A few things happen when a change in classification occurs:

  • The entity will make a check-the-box election with an effective date after the date that the entity was formed.
  • When an entity that was initially classified as a corporation elects to change its classification either to a partnership or a disregarded entity, the entity is considered liquidated.
  • The entity cannot change its classification again for 5 years (the "60-month rule").

On the other hand, an “initial classification” does not require any of the transactions that a “change in classification” has, and the entity is able to change its classification at any time thereafter. This may seem safe, but in the cross-border setting, the outcome could be dreadful. In the cross-border setting a stepped-up basis in the assets received to their fair market value can often be obtained without prompting U.S. federal tax liability. However, in order to create this outcome, the check-the-box election for the foreign entity must generate a “change in classification” – which has made people wonder if the foreign entity's classification was never relevant, does a check-the-box election result in a “change in classification” or an “initial classification.”

The recent IRS guidance clarified that an election by an entity whose classification was previously never relevant results in a change in the entity's classification and will carry the tax consequences as it treated as a “change in classification.”

The key point from the IRS guidance is during a scenario where a foreign entity whose classification has never been relevant, it would appear that only a single election is required to produce a “change in classification.”

Like most IRS guidance, these kinds of scenarios invite follow-up questions. Therefore, it’s always wise to consult with an experienced and well-versed tax professional before implementing any changes, particularly in the pre-immigration setting, where the risks are high. Global Taxes is always here to help explain changes to tax laws. Give us a call (212) 803-3327 or schedule a consultation on our website

About the Author

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high net worth families and their advisors. Alicea has more than 17 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm. Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S. Alicea is fluent in Spanish and has a working knowledge of Portuguese.

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA Forty Under 40 Award. She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth's Powerwomen Awards in the category USA - Woman of the Year - Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique). Furthermore, Alicea is currently listed in the Global Elite Directory 2023, which is an annual exclusive directory of the world's elite lawyers and outstanding wealth advisors advising ultra-high net-worth clients.

Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.

Credits: Supplied Image; Author: Client;

Alicea Castellanos, CPA, TEP, N.P.

CEO & Founder

Global Taxes LLC

Tax Advisory & Compliance Services

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