Form 8832 – Avoiding double taxation in the U.S. and Canada

The IRS Form 8832, Entity Classification Election, is a tax form that allows businesses to choose how they want to be classified for federal tax purposes. This election gives certain eligible businesses the flexibility to be taxed in a way that best suits their financial structure and goals.

Who Needs to File Form 8832?

Any eligible business entity can file Form 8832 to change its default tax classification. The following types of businesses may need to file:

1. LLCs (Limited Liability Companies): By default, a single-member LLC is treated as a disregarded entity (taxed as a sole proprietorship), and a multi-member LLC is treated as a partnership. However, LLCs can use Form 8832 to elect to be taxed as a corporation or as an S-corporation.
   
   Both single-member and multi-member LLCs can file Form 8832 if they want to be taxed as a C corporation rather than as an LLC.
   
2. Partnerships: general partnerships, limited partnerships and limited liability partnerships can file Form 8832 to elect to be taxed as a C corporation.
   
3. Unincorporated associations: certain entities, such as trusts or cooperatives, can also file this form if they wish to change their tax classification and be taxed as corporations.
   
4. Certain Foreign Entities: some foreign businesses are eligible to be treated as a corporation for tax purposes. These entities can file Form 8832 to select their tax classification under US tax law.
   
5. Corporations: If a corporation wants to revert to being taxed as an LLC or a partnership, Form 8832 can facilitate this change.

Not all businesses need to file Form 8832. If a business is satisfied with its default tax classification, it can continue filing taxes under that structure without submitting this form.

Benefits of Filing Form 8832

Filing Form 8832 offers several potential advantages, depending on the business’s financial situation:

1. C-corps are taxed at 21%—a lower rate than pass-through structures. An LLC can elect to be taxed as a corporation if that offers a better tax outcome. This could be beneficial for owners looking to reduce self-employment taxes or take advantage of lower corporate tax rates.
2. Write off salaries/bonuses, health insurance premiums, charitable donations, and more
3. Carried losses
4. Flexible fiscal year parameters

However, filing form 8832 does expose owners to double-taxation, as C-corps are not pass-through entities. Therefore, generally, larger businesses will file as a C-corp. But smaller, growth-oriented businesses can benefit from the designation because taxes are paid at a lower rate, and write-offs can more than cancel out the double-taxation.

The 60-month limitation rule

Once a business has elected a new classification by filing Form 8832, it is subject to the 60-month limitation rule. After making this election, the business is typically restricted from making another classification change for 60 months, or 5 years. This rule prevents businesses from exploiting frequent changes to their classification for tax advantages.

However, it’s important to note that there are exceptions to the 60-month rule. For example, if a business made its election under a mistake of fact, the IRS may permit a change sooner than 60 months. Another exception to this rule is when more than 50% of the ownership of a business changes – when this occurs, the IRS may allow an earlier election.

What’s the deadline to file Form 8832?

You can file IRS Form 8832 at any time. You might choose to file it at the same time you start your business, or you might decide to file at a later point. Additionally, you can choose the effective date of your election – within certain timeframes.

Generally, your effective date:

• Cannot be more than 75 days before your Form 8832 is filed
• Cannot be more than 12 months after your Form 8832 is filed

If you don’t choose a date, then the effective date will be the same as the date on the Form.

Businesses generally should file the form within 75 days of the desired effective date of the new tax classification. This means you can backdate the classification change as long as it’s within 75 days of the filing date or choose an effective date up to 12 months in the future.

However, if you miss the 75-day window, you might still be able to request late election relief. The IRS will allow late elections in some circumstances, provided that certain criteria are met.

Filing Form 8832: Step-by-Step Guide

Here’s a step-by-step breakdown of how to fill out Form 8832 and the details to keep in mind:

1. Basic Entity Information

• Part I, Line 1: Entity Name and Address
  Begin by filling out your business’s full name and mailing address, which includes the name of the company, the mailing address, city, state, and ZIP code.
• Part I, Line 2: Employer Identification Number (EIN)
  Enter the business’s Employer Identification Number (EIN). If your business does not yet have an EIN, you must apply for one from the IRS before filing Form 8832. The EIN is essential for identifying your business in all communications with the IRS.
• Part I, Line 3: Date of Formation
  Enter the date your company was officially formed, such as the date on which your LLC or corporation was registered with the state.
• Part I, Line 4: Type of Election
  Here, you will specify the type of election being made. The options include electing to be classified as a corporation, partnership, or disregarded entity. Additionally, you’ll need to indicate the effective date of the tax classification change, which can be retroactive up to 75 days before the filing date or as far as 12 months into the future.
• Part I, Line 5 & 6: Classification Information
  Choose the current and desired tax classification of your business. This could include changing from a disregarded entity (for single-member LLCs) or partnership (for multi-member LLCs) to a corporation.
• Part I, Line 6: Foreign Entities
  If your business is a foreign entity (i.e., incorporated outside the U.S.), you will need to provide additional details about the country of incorporation and any applicable tax treaties.

2. Part II: Owner Information

This section is where you list the business’s owners or members. For a business with a 100% non-resident shareholder, the shareholder’s information must be included. You will provide details like their name, address, and tax residency status. Since foreign ownership can trigger unique tax obligations, it’s essential to ensure this section is completed accurately.

3. Part III: Late Election Relief

If your company missed the deadline to file Form 8832 within 75 days of the desired effective date, you can request late election relief in this section. The IRS may grant relief if your company meets certain requirements, such as having reasonable cause for the late filing.

4. Signature and Submission

The form must be signed by an authorized individual, such as the business owner, manager, or corporate officer. Once signed, the form should be mailed to the appropriate IRS address listed in the form’s instructions.

Impact of Form 8832 on 100% Non-Resident Shareholders

When a company has a non-resident shareholder, the IRS’s tax classification rules can become more complex. Electing the proper tax structure with Form 8832 can have significant benefits for both the company and its non-resident shareholders, particularly those who own 100% of the business.

1. Tax Classification Flexibility

For LLCs with non-resident shareholders, filing Form 8832 is often necessary to maintain tax compliance. By default, an LLC with a single owner is classified as a disregarded entity and taxed as a sole proprietorship. For U.S. residents, this structure allows the business’s income to pass through to the owner’s personal tax return. However, if the owner is a non-resident foreign person, the disregarded entity classification may not be ideal.

A non-resident cannot report income on a U.S. Form 1040 as a U.S. citizen would. In such cases, electing to be taxed as a C-corporation is often the best solution. By doing so, the company becomes a separate taxable entity, and the non-resident shareholder is only taxed on any U.S.-source income (such as dividends).

2. S-Corporation Restrictions

U.S. tax law prohibits non-resident foreign persons from owning shares in an S-corporation. Therefore, if a company was previously an S-corporation and a non-resident shareholder is introduced, the company would automatically lose its S-corporation status. Filing Form 8832 allows the business to proactively elect C-corporation status, ensuring compliance with the law and maintaining a clear tax structure.

3. Withholding Taxes

Non-resident shareholders are subject to U.S. withholding taxes on certain types of income, such as dividends. The U.S. requires withholding of up to 30% on payments made to non-resident foreign persons, although tax treaties between the U.S. and certain countries may lower this rate. Electing to be taxed as a corporation simplifies the process by ensuring that the company handles withholding and reporting properly, minimizing the risk of non-compliance.

Impact on U.S. Visa for Non-Residents

Filing Form 8832 may also have implications for the non-resident shareholders’ U.S. visa status, particularly in relation to investments and immigration law. Here’s how:

1. Investor Visas (E-2 Visa): Some non-residents who invest in U.S. businesses seek an E-2 Investor Visa. This visa allows them to live and work in the U.S. based on their investment in a U.S. business. Filing Form 8832 to elect the appropriate tax structure can support the business’s growth and profitability, helping meet the requirements for the E-2 visa, which mandates that the investor’s enterprise must be actively operating and generate significant revenue.
   
2. Tax Filing Requirements for Non-Resident Visa Holders: Non-resident shareholders are required to file tax returns in the U.S. to report any income received from U.S. sources. Depending on the visa type, non-resident shareholders might need to file Form 1040NR or other IRS forms that apply to foreign income. Electing a corporate tax structure via Form 8832 can streamline the tax reporting process, both for the business and the non-resident shareholder, by clearly defining how income is classified and taxed.
   
3. Green Card Holders: If a non-resident shareholder becomes a lawful permanent resident (green card holder) during their ownership period, the company’s tax classification will continue to be important. Non-resident investors planning to apply for a green card should consider how their company’s tax election could impact their future tax liabilities, as green card holders are taxed on worldwide income.

Case Study: Anna’s E-commerce Business in the U.S. – A Canadian Non-Resident Shareholder

Anna, a successful entrepreneur from Canada, decided to expand her online e-commerce business into the U.S. market in 2023. She formed a single-member LLC in Delaware, called Anna’s Trendy Goods LLC, with the goal of reaching a larger customer base in the U.S. As a non-resident of the U.S., Anna encountered specific tax issues that required her to carefully consider how her business would be taxed under U.S. law.

1. The Initial Setup and Default Classification

Initially, because Anna was the sole owner of her LLC, the IRS treated her business as a disregarded entity for U.S. tax purposes. In this default classification, the LLC’s profits and losses would flow directly through to Anna’s personal tax return. For U.S. residents, this pass-through treatment is common and provides certain tax benefits.

However, Anna, as a Canadian non-resident, could not file a U.S. tax return in the same way a U.S. citizen or resident could. Moreover, the disregarded entity classification would complicate her tax situation. Without electing a different classification, Anna would have to report the LLC’s U.S.-source income on her Canadian tax return, which could lead to double taxation issues and unnecessary complications in complying with U.S. tax laws.

2. Filing Form 8832: The Need for a Tax Reclassification

To address these issues, Anna’s tax advisor recommended filing IRS Form 8832 to change the LLC’s tax classification from a disregarded entity to a C-corporation. This election would allow Anna’s LLC to be treated as a separate legal entity for U.S. tax purposes, simplifying her tax reporting obligations as a non-resident.

By electing C-corporation status, Anna’s company would pay U.S. corporate income tax directly on its profits, and Anna would only be taxed on the dividends she received from the company. This separation of business and personal income would also help Anna avoid potential conflicts with Canadian tax authorities regarding the treatment of the LLC’s income.

3. The Filing Process for Form 8832

Anna followed these steps to file Form 8832:

• Basic Information: She entered the name and EIN (Employer Identification Number) of her business, along with the date it was formed in Delaware.
• Election of Tax Classification: On the form, Anna checked the box to elect C-corporation status and set the effective date of the election as January 1, 2024. This meant that starting from that date, Anna’s Trendy Goods LLC would be treated as a C-corporation for U.S. tax purposes.
• Foreign Entity Section: Although her LLC was formed in the U.S., Anna, as a Canadian resident, had to complete the part of the form that asked about foreign entities and shareholders.

After completing and signing the form, she submitted it to the IRS and waited for confirmation of her election.

4. Impact of the Election on Anna’s Taxes

By filing Form 8832, Anna successfully changed her LLC’s tax classification to a C-corporation. This decision had several key benefits for her as a non-resident shareholder:

• Simplified Tax Reporting: As a C-corporation, her business would now pay U.S. corporate tax at the company level, avoiding the need for Anna to directly report the LLC’s income on her personal tax returns in both the U.S. and Canada.
• Dividend Withholding Tax: Instead of being taxed on the business’s total income, Anna would only be taxed on the dividends she received from her U.S. business. Since she is a Canadian resident, the U.S. applies a 30% withholding tax on dividend payments to non-resident shareholders. However, thanks to the U.S.-Canada Tax Treaty, Anna was able to reduce this withholding rate to 15%, saving her a significant amount in taxes.
• Avoiding Double Taxation: The tax treaty also helped Anna avoid double taxation, allowing her to claim foreign tax credits in Canada for the taxes she paid in the U.S. This ensured that she didn’t end up paying both the U.S. and Canadian governments for the same income.

5. Anna’s Business Success

Thanks to her tax advisor’s recommendation and her decision to file Form 8832, Anna’s Trendy Goods LLC was able to operate smoothly in the U.S. market without any major tax complications. Anna received regular dividends from the business, and because of the U.S.-Canada Tax Treaty, she paid a reduced withholding tax rate on these dividends.

The election to become a C-corporation helped Anna avoid the complexities of being taxed as a disregarded entity or partnership, and ensured that her U.S. business complied with all applicable U.S. tax laws while minimizing her overall tax burden.

Conclusion

For non-resident shareholders like Anna, electing the appropriate tax classification through Form 8832 can simplify the tax process and reduce potential tax liabilities. By changing her LLC to a C-corporation, Anna avoided the complicated tax issues that could arise with pass-through entities and ensured that she could benefit from the provisions of the U.S.-Canada Tax Treaty.

In the U.S., non-resident shareholders face unique tax challenges, but the proper tax election can turn these challenges into opportunities for effective tax management and business growth. For Canadian entrepreneurs expanding into the U.S., like Anna, filing Form 8832 is an essential step in optimizing tax compliance and success.