IRS Extends Relief for Late “Check-The-Box” Elections
The U.S. Internal Revenue Service (IRS) has just made it easier to obtain relief for the late filing of check-the-box (CTB) elections by extending the period of time after which the election was due during which taxpayers can use the more simplified method of obtaining relief instead of having to apply for a letter ruling (a much more comprehensive and expensive process).
In general, this will help taxpayers who discover up to three years later that they have not made a CTB election which they originally intended to make.
IRS regulations provide rules for when a business organization will be treated as a corporation or a pass-through entity for U.S. tax purposes (the so-called default classification rules). An eligible entity may elect to change (or confirm) its classification for tax purposes by filing IRS Form 8832 within 75 days of the desired effective date of the classification.
This election is commonly used, for example, in the structuring of private equity funds and hedge funds and their foreign investments where it is desirable that an entity be treated as a corporation under local corporate and tax law but as a pass-through entity for U.S. tax purposes (or vice-versa). In many cases, taxpayers who fail to file CTB elections for the structure they have implemented face very negative U.S. tax consequences for their investors.
Under the old rules (in Rev. Proc. 2002-59), if a taxpayer discovered it had failed to make a CTB election within the 75-day period, it could request relief under a relatively simple procedure by filing the form and attaching a statement explaining that the taxpayer had reasonable cause for not making the election on time. While not automatic, this relief was generally granted by the IRS. However, in order to be eligible for this simple procedure, (a) the election had to be for an entity which was newly formed under local law (as opposed to an election to change the classification of, for example, a previously existing so-called shelf corporation), and (b) the due date for the first federal tax return (excluding extensions) of the entity’s desired classification for the year of the entity’s formation could not have passed.
For example, if a hedge fund, organized as a Cayman corporation, was newly formed on January 1, 2008, it would typically want to file a CTB election by March 15, 2008 (within 75 days) so that its U.S. partners could obtain flow-through tax treatment. If it failed to file the election by then, it would generally have until March 15, 2009, the due date of its tax return (without extensions), to file under the relatively simple procedures noted above.
If discovery of the missed filing was made beyond that point, the only available recourse was to file a request for a letter ruling with the IRS, a far more complex process which entails an IRS user fee, as well as necessary professional advice and fees. Similarly, if the Cayman corporation was not newly formed, but acquired (as a dormant shell), the only recourse for failing to file beyond March 15, 2008 was to file a request for a letter ruling with the IRS.
In Rev. Proc. 2009-41, which will be published and effective on September 28, 2009, the IRS replaces the old rules described above with substantially similar rules which can be used by taxpayers (a) making an election to change an entity’s classification (not just for a newly formed entity), or (b) requesting relief for an election that should have been filed up to 3 years earlier (i.e., 3 years and 75 days from the requested effective date). Accordingly, in the above example, the Cayman corporation would have until March 15, 2011 to file its late election without requesting a letter ruling from the IRS.
There are, however, some new rules which were not applicable under the old procedure:
- In order to be eligible for this relief, the entity seeking an extension of time to make the election must have timely filed (within 6 months of its due date excluding extensions) all required U.S. tax and information returns consistent with its requested classification* for all of the years the entity intended the requested election to be effective; or
- If the entity for which the election is being made is not required to file a U.S. tax return, each “affected person” (i.e., generally, a taxpayer who is required to attach a copy of the election to its tax return under IRS regulations) must have timely filed (within 6 months of its due date excluding extensions) all required U.S. tax and information returns consistent with the entity’s requested classification* for all of the years the entity intended the requested election to be effective (in general, a partnership which directly or indirectly owns an interest in the entity making the election, and not its partners, would typically be an affected person); and
- The reasonable cause statement that is required to be attached to the late-filed election must be signed and dated by an authorized representative of the eligible entity and the affected person(s), if any, under the penalties of perjury and the individual(s) who signs must have personal knowledge of the facts and circumstances related to the election.
Window of Opportunity
Taxpayers who failed to file a desired election that should have been filed during 2008 and wish to file for relief under the new rules will only be eligible to do so if they file their 2008 tax and information returns in a manner consistent with the election within 6 months of the original due date without extensions.
This suggests that if, for example, a hedge fund organized as a Cayman corporation during 2008 failed to make a CTB election to be treated as a partnership, it should file Form 1065 (i.e., a partnership tax return as opposed to a corporate tax return) by September 15, 2009 in order to be eligible for this new relief on September 28, 2009 or thereafter.
To consider a different example, a private equity fund, organized as a U.S. partnership, that acquired during 2008 a controlling interest in a foreign corporation which is not required to file a U.S. tax return and which failed to make a CTB election to be treated as a partnership, apparently should file Form 8865 (i.e. to report in respect of a foreign partnership as opposed to Form 5471 in respect of a foreign corporation) by October 15, 2009 (6 months after the original due date of the private equity fund’s Form 1065, notwithstanding that this form is due on final extension by September 15, 2009) in order to be eligible for this new relief.
However, based on informal discussion with the IRS author of the new rules in Rev. Proc. 2009-41, if a taxpayer has already filed its tax return (whether because it was due or otherwise) in an inconsistent manner, it is apparently not eligible for this new relief even if it files an amended return in a consistent manner within these time frames.
Pending Requests for Relief
The new rules apply to requests pending with the IRS pursuant to the old rules on
September 28, 2009 and to requests received thereafter.
If an entity has filed a request for a letter ruling seeking relief for a late-filed CTB election, and that request is pending with the IRS on September 28, 2009, the entity may rely on the new rules which do not require a letter ruling, withdraw the letter ruling request and receive a refund of its user fee. However, the IRS will process letter ruling requests pending on September 28, 2009 unless, prior to the earlier of November 12, 2009 or the issuance of the letter ruling, the entity notifies the IRS that it will rely on the new rules and withdraws its request.
For more information, please contact your Frank, Rimerman + Co. LLP tax professional.
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