United States

IRS grants taxpayer permission to change entity classification

TAX ALERT  | 

The IRS, in a recent private letter ruling (PLR) granted relief to a taxpayer from the rule imposing a five-year (60-month) period during which an entity classification election generally may not be changed (PLR 201840008).

The “check-the-box” regulations generally give unincorporated business entities an election to be taxed either as partnerships or corporations, or as disregarded entities if they have only a single owner. The regulations also provide that once an eligible entity makes an entity classification election, that entity generally may not change its classification (via a new entity classification election) until the expiration of five years (60 months) following the effective date of the election.

In this PLR, Entity 1 was initially formed as a limited liability company (LLC) with a single owner and thus, per the regulations, was disregarded as an entity separate from its owner for tax purposes. At a later date, Entity 1 filed an election to be treated as an S corporation. Pursuant to the applicable regulations, that election was treated as a deemed, simultaneous election to be treated as a corporation (not a disregarded entity), since that is implicit in the election to be treated as an S corporation. Still later, but prior to the end of the 60-month restriction period, Entity 1 experienced a greater-than-50-percent change in ownership. Based on that change in circumstances, Entity 1 requested a waiver of the 60-month rule, so that it could elect to be classified as a partnership instead of an S corporation.

This action was consistent with regulations allowing (but not mandating) that the Commissioner grant such a waiver where there is a greater-than-50-percent change in ownership. While the outcome is thus not surprising, it is an important reminder to taxpayers and their advisors of the importance of careful planning in entity selection, since there is only limited flexibility to change elections. 

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