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One of the most critical decisions a business based in the United States must make is its tax classification. Fortunately, organizations have some flexibility in this choice, so you can align your tax liability with your unique operational needs and growth goals. Once you choose, you’ll need to fill out Internal Revenue Service Form 8832.
Each tax classification comes with unique benefits and business considerations, influencing everything from tax rates and liability exposure to funding opportunities and compliance requirements.
So, what is Form 8832? Read on to learn what Form 8832 is used for, when and where to file it, and what factors to consider when making this important decision.
What is IRS Form 8832?
Form 8832, aka Entity Classification Election, is an IRS form that allows entities to choose their federal tax classification. This is a crucial step for new businesses since tax classification can significantly impact tax liability and compliance requirements. If a business doesn’t file Form 8832 with the IRS, default classification rules will apply based on the business structure. These rules may not align with the company’s financial goals or operational needs.
Here are the three tax classification options:
- Corporation: A corporation is considered a separate legal entity from its owners, giving limited liability protection to shareholders. It is subject to corporate tax rates. Corporations may face double taxation—the company’s profits are taxed at the corporate level, and dividends distributed to shareholders are taxed on personal income returns.
- Partnership: A business with two or more owners can be classified as a partnership. Profits are taxed on an individual level, also known as pass-through taxation. This means the business itself doesn’t pay income tax. Instead, partners report profits on their federal tax returns. Partnerships offer flexibility in management and profit distribution, which is enticing to small, collaborative ventures.
- Disregarded entity: Entities with a single owner, such as sole proprietorships and independent contractors, typically opt for a disregarded entity. Although the business is considered separate for liability purposes, income and losses are reported directly on a personal tax return.
Who needs to file IRS Form 8832?
Businesses file Form 8832 when the default tax classification assigned by the IRS doesn’t align with their organizational needs. Here are the types of businesses that can elect to change their tax classification:
Limited liability companies (LLCs)
An LLC is a business entity filed at the state level that can be classified as a disregarded entity or partnership by default. As LLCs hire more employees, they might elect to become classified as a corporation to offer better benefits (e.g., stock options) and attract investment. LLCs can choose to be classified and taxed as an S corporation or a C corporation.
- S corp: This classification allows for pass-through taxation. Income, losses, deductions, and credits are reported on personal tax returns. S corps have limited liability protections that safeguard personal assets from business debts and other liabilities. To be taxed as an S corp, an entity must file Form 2553 instead of Form 8832.
- C corp: This type of entity also provides shareholders with limited liability protections. C corps are subject to double taxation, where profits are taxed at the corporate level, and dividends are taxed on personal income tax returns. The benefit of a C corp is greater flexibility in raising capital since it can have unlimited shareholders and different classes of stock.
Partnerships
General partnerships, limited partnerships, and limited liability partnerships can file Form 8832 to switch to a C corporation.
Unincorporated associations
Trusts and cooperatives may also use Form 8832 to alter their tax classification and be taxed as a corporation.
Certain foreign businesses
Some foreign entities can elect to be treated as corporations, which can help them gain direct access to U.S. markets, simplify international tax compliance, or attract investors who prioritize familiar regulatory and legal frameworks.
When to file IRS Form 8832
Consider growth objectives, changes in organizational structure, and your current tax classification before electing a new entity classification. Here are some common scenarios where you may want to file Form 8832:
Initial classification
New businesses that don’t choose their tax classification will have a tax classification selected for them by the IRS. If that classification doesn’t align with your business’s goals, you’ll need to file Form 8832 within 75 days of the business’s formation.
Change an existing classification
If an existing business wants to change its tax classification, it needs to file Form 8832. Here are the deadlines:
- 75-day rule: The entity must file Form 8832 at least 75 days before the date it wants the new classification to take effect.
- 12-month extension: If the business misses the 75-day deadline, it can still file Form 8832 within 12 months after the desired effective date. The IRS may request special documentation to explain why your filing is overdue.
Major organizational change
Significant organizational structure changes (e.g., mergers, acquisitions, or new partners) may affect your tax classification. Entities must follow the 75-day rule and file Form 8832 within 75 days of the change.
Post-60-month period
If you’ve filed Form 8832 to elect a tax classification, you must wait 60 months before you can do it again to change your entity’s status. Some scenarios may let you get around the 60-month rule (e.g., when 50% of the ownership interests switch to persons who had no interest in the entity on the date of the last reclassification).
Correct mistakes
If you misclassify or file Form 8832 with errors, you must make corrections with the IRS as soon as possible. The IRS will likely ask for additional information and supporting documents to accept a new, correct Form 8832.
What to do if you’ve never filed IRS Form 8832
If you never filed a Form 8832, the IRS will automatically classify your entity as a corporation, partnership, or disregarded entity. If you need to change your tax classification, follow these steps:
- Determine your eligibility: Ensure your entity is eligible to file Form 8832 based on its current structure and desired classification.
- Complete Form 8832: Carefully follow Form 8832’s instructions, providing accurate information, explanations, and documentation for the new tax classification.
- File on time: If you’re a new business, file within 75 days of your entity’s formation date to have your tax classification effective from the start of your business’s operation. If you need to change an existing classification, follow the 75-day rule or 12-month extension as outlined above. Be prepared to provide the IRS with a strong justification for filing late.
- Submit the form: Send your completed form to the IRS. Form 8832 provides instructions about where to file Form 8832 based on your state or country of operation.
- Keep records: File a copy and any relevant correspondence with the IRS for safekeeping and easy access.
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