What You Need to Know About Entity Classification Election

Business entities may elect to be treated as corporations taxed at the entity and member levels or as "flow through" entities taxed only at the member level. However, entities organized as corporations under U.S. state laws and certain foreign entities are treated as corporations, with no optional election.

Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Federal tax rates on corporate taxable income vary from 15% to 39%. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable.

There is an entity in charge of regulating the inflow of resources through tax collection in the country: The Internal Revenue Service. The Internal Revenue Service is the revenue service of the United States federal government. Is important to know that the government agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue.

The Internal Revenue Service s responsible for collecting taxes and the administration of the Internal Revenue Code. It has also overseen various benefit programs, and enforces portions of the Affordable Care Act.

Is also important to remember that some entities treated as corporations may make other elections that enable corporate income to be taxed only at the shareholder level, and not at the corporate level. Such entities are treated similarly to partnerships. The income of the entity is not taxed at the corporate level, and the members must pay tax on their share of the entity's income.

An entity which is eligible to make an election is referred to as an eligible entity. Generally, a corporation organized under the United States federal or state statute, and referred to as a corporation, body corporate or body politic by that statute, is not an eligible entity.

Reform business entity classification rules for foreign entities: Under the proposal, a foreign eligible entity may be treated as a disregarded entity only if the single owner of the foreign eligible entity is created or organized in, or under the law of, the foreign country in, or under the law of, which the foreign eligible entity is created or organized.

Therefore, a foreign eligible entity with a single owner that is organized or created in a country other than that of its single owner would be treated as a corporation for federal tax purposes. Except in cases of the United States of America tax avoidance, the proposal would generally not apply to a first-tier foreign eligible entity wholly owned by a United States person. The tax treatment of the conversion to a corporation of a foreign eligible entity treated as a disregarded entity would be consistent with current Treasury regulations and relevant tax principles.

For the record, a business entity is an entity that is formed and administered as per commercial law in order to engage in business activities, charitable work, or other activities allowable. Most often, business entities are formed to sell a product or a service. There are many types of business entities defined in the legal systems of various countries. These include corporations, cooperatives, partnerships, sole traders, limited liability company and other specifically permitted and labelled types of entities.

The following types of business entity are treated as eligible entities:

●     An eligible entity that previously elected to be an association taxable as a corporation.

●     A foreign eligible entity that became an association taxable as a corporation under the foreign default rule.

●     A foreign corporation that is not identified as a corporation under Treasury regulations.

A quick glance at history

Long before 1996 entities both domestic and foreign were classified as corporations or not based on the called "multi-factor test", which looked at limited liability; continuity of life; free transferability of interests; centralized management; associates; objective to carry on business for joint profit.

The initial regulations also included a list of foreign entities which would always be classified as corporations and which could not elect to be disregarded.

The first federal income tax was enacted in 1861 and expired in 1872, amid constitutional challenges. A corporate income tax was enacted in 1894, but a key aspect of it was shortly held unconstitutional. In 1909, Congress enacted an excise tax on corporations based on income. After ratification of the Sixteenth amendment to the United States of America Constitution, this became the corporate provisions of the federal income tax. Amendments to various provisions affecting corporations have been in most or all revenue acts since. Corporate tax provisions are incorporated in Title 26 of the United States Code, known as the Internal Revenue Code. The present rate of tax on corporate income was adopted in the Tax Reform Act of 1986.

Take a look to this article to learn how to reduce your personal and business taxes.

A Brief Look at Tax Changes Throughout US History

Image courtesy Jimmie | Flickr

Benjamin franklin said it “In this world, nothing can be said to be certain, except death and taxes”. And he was totally right. Taxes have been in our lives forever, since we can remember our grandparents paid taxes, our parents paid taxes and we ended up paying taxes as well. We also know that these taxes tend to change, not to be cheaper or softer, and tend to regulate almost any activity in our day to day lives.

But how has taxation changed in the United States? More importantly, what are those changes that have marked the history of the tax system in the Unites States? Surprisingly, at the beginning, America was tax-free for much of its early history. At least, it was free of direct taxation like income tax. We have to remember that it was taxation that led to the revolution against the British in 1773 and after that, one of the first challenges the new system faced was the Whiskey Rebellion. This rebellion was all about groups of Pennsylvanian farmers angry about the tax on whiskey burning down tax collectors' houses and tarring and feathering any collectors too slow to get away. It is well remembered because the congress handled the situation using military force because they had the right to collect indirect taxes for the nation.

Since this date, taxation has had many changes, some good and necessary, others not so favourable for some people and at times unfair. Let’s take a look at those moments in taxation history that are worthy to remember and that gave an amazing boost to the North American economy.

Near the previous date, in 1790, taxation had a big addition to its variety. A war with France led the government to impose a property tax and a further modification to it in 1812 with the first income tax approach after a civil war. Of course the consequences of the war, specially a war against oneself as a civil war is, are totally negative. The American Civil War was very expensive for the nation because there was an amazing rate of debt that had to be acquired in order to carry out such war. In order to help pay for the war, the Congress passed the Revenue Act of 1861 which taxed incomes exceeding $800, and was not rescinded until 1872. Many scholars consider that it was this act that created most of what it is considered as the modern tax system. That same year the U.S. Internal Revenue Service (IRS) was founded as a consequence of arranging such taxes and making the government machinery work perfectly.

In 1895 there was a big game changer.  Although the Constitution forbade any direct taxes that were not levied in proportion to each state's population, the Supreme Court declared a flat tax contained in the 1894 Wilson-Gorman Tariff Act unconstitutional. This was a huge victory for all the taxpayers because now it was a bit fairer the way they were going to be charged for their taxes. This started a feeling in people´s hearts that taxes could also bring negative consequences to world trade and for underprivileged people. After this, the 16th Amendment was introduced in 1913 and that gave way to one type of income tax for the population and a further income tax for people with an annual income of over $3,000. This tax touched less than 1% of Americans and gave the government the possibility to control high incomes that came from anonymous societies or big partnerships and that were free from being charged as a group. (This was one of the mechanisms used to get to Al Capone´s finances and money movements)  

Image courtesy DonkeyHotey | Flickr

For the Second World War and for his new approach to the country called The New Deal, Roosevelt introduced many taxes and increased many others. For Roosevelt´s New Deal there was a huge deficit that had to be covered by imposing and collecting more taxes. By the end of 1936 there was a top tax rate 76% and the economy couldn’t take it. Taxes were then raised several more times and only the corporate tax changed for good lowering its tariff. The war came and America needed money to support their allies so a more aggressive taxation was imposed. By 1945, 43 million Americans paid tax and the amount of taxes collected went from $9 billion in 1941 to $45 billion in 1945.

All these changes in taxation in the United States came after big issues in the government or society or after wars in and outside of the country. We all know that taxes are totally necessary, but we also known that those same taxes make our lives a little bit more difficult. Learn more about taxation in this article