Check-the-box: choosing an entity's tax classification.

The Internal Revenue Service has finalized rules that allow most businesses to choose whether they will be treated as a corporation or as a passthrough entity such as a partnership. Check-the-box rules also allow businesses to disregard their entity status for federal income tax purposes. For example, under the default classification system, a domestic single-owner entity is taxed as a sole proprietorship if the owner is an individual or as a division if the owner is a corporation, unless the entity elects to be taxed as a corporation.

The single-owner entity would not have to file a separate tax return; rather, it would simply report taxable income on Schedule C, Profit and Loss From Business, as a part of the owner's form 1040.

For some time now, companies have made use of so-called hybrid entities, such as limited liability companies, to take advantage of certain domestic and international tax breaks. These hybrid entities have both corporate and noncorporate characteristics--they can enjoy the liability protections of corporations but are not necessarily taxed as corporations. Under the check-the-box rules, businesses can avoid having to carefully structure hybrid entities to realize these benefits.

Observation: The final check-the-box rules have important implications for the taxation of domestic and international operations. The "tax nothing" box could be chosen to achieve combined or consolidated reporting in states that restrict or prohibit combination and consolidation. At the federal level, subsidiaries whose separate status is disregarded may offer benefits of consolidated reporting without the negative aspects of the consolidated return rules. Certain foreign entities also may be "tax nothings" or partnerships, allowing companies to simplify their international structures and take advantage of planning opportunities.

Taxpayers should be aware of the check-the-box regulations' default classification system so they do not miss making the necessary election. The default rules differ depending on whether the entity is foreign or domestic. Some foreign entities, such as a British public limited company, are per se corporations under the rules, and alternative treatment cannot be elected. Furthermore, taxpayers should verify if these rules apply to their state filings. --Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.