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If you’re a US expat with your own business, you’ll want to read up on Form 8832: Entity Classification Election.
With this form, you can choose how the government classifies your business for US federal tax purposes. Understanding the implications of Form 8832 can help you determine the best tax strategy for your business — even if you ultimately don’t end up making an election.
Below, we’ll dive into the details of Form 8832, from what it does to who should file it, when it’s due, and more.
What is Form 8832?
Form 8832 lets an eligible entity choose their business classification for tax purposes. Keep in mind, though, that the entity type you choose (sole proprietorship, partnership, or C-corporation) must, in reality, match your business structure.
The election you can makedepends in part on how many owners your business has. A business with one owner can have the IRS tax them as either:
- A sole proprietorship, OR
- A corporation
Businesses with two or more owners, on the other hand, can choose for the IRS to tax them as either:
- A partnership, OR
- A corporation
Who needs to file Form 8832?
Not all business owners need to file Form 8832. The government automatically classifies one-owner businesses as sole proprietorships and businesses with two or more owners as partnerships.
In some cases, business owners who would otherwise pay taxes as sole proprietors/partners may benefit from electing corporation status (we’ll get into why later) — and they would need to file Form 8832 to opt into their preferred tax treatment.
Let’s put that into context with an example:
Issa Martínez is a US citizen and digital nomad who works as an independent contractor. By default, the IRS classifies her company as a sole proprietorship. So as long as that classification is in her best financial interest, she won’t need to file Form 8832.
However, let’s say that Issa schedules a consultation with an expat tax professional. In this meeting, she learns that tax treatment as a corporation would be more favorable for her. To receive that beneficial tax treatment, she must submit Form 8832 to officially classify her business as a corporation.
Which business entity type is right for me?
Now, you’re probably wondering how the different business entity types we mentioned get taxed. We’ll go over that — as well as who tends to benefit from these elections — below.
B!T note: The tax rates that follow do not include state or local taxes. Businesses registered in a state may be subject to additional income, unemployment, disability, payroll and other types of taxes.
Sole proprietorship & partnership taxes
Both sole proprietorships and partnerships are pass-through entities. Under this form of taxation, each member pays individual taxes on their share of the business income. Individual taxes on ordinary income range from 10% to 37%, depending on total income. Members must also pay a 15.3% self-employment tax to cover Social Security (12.4%) and Medicare (2.9%) contributions.
This option is generally best for businesses that:
- Prefer a simpler administrative process
- Are small and plan to stay small
- Bring in less than $80,000 in net income
Corporation taxes
Corporations pay taxes in one of two ways, depending on whether they fall under the C-corporation (C-corp) or S-corporation (S-corp) classification.
C-corporation taxes
C-corps pay taxes at the flat corporate rate of 21%. Shareholders also pay personal income tax rates (10% to 37%) on any dividends or profits that are distributed to them from the c-corp, effectively resulting in double taxation of profits. C-corps must also pay federal payroll taxes on wages paid to shareholder employees at a rate of 7.65% for the employer, the employee being responsible for an additional 7.65%.
This option is generally best for businesses that:
- Are already large or plan to grow
- Want flexibility when it comes to:
- Stock options
- Number of shareholders
- Opportunities to raise capital
S-corporation taxes
S-corps are pass-through entities too, but the way they pay taxes is a bit more complex than sole proprietors/partners. S-corp owners pay payroll taxes of 15.3% on the “reasonable salary” they designate for themselves, rather than all of business profits. This makes it a favorable business structure for growing sole proprietorships who begin earning above the $80,000 threshold.
This option is generally best for businesses that:
- Earn more in profit than their role would demand as a reasonable salary (which has some subjectivity associated with it. Read more: LINK
- Are willing to take on greater administrative & tax filing complexity for tax savings
- Don’t plan to distribute multiple kinds of stock
- Don’t plan to have more than 100 shareholders
- Don’t have non-US citizen shareholders
Important note:
Electing corporation status on Form 8832 will classify you as a C-corp for tax purposes, not an S-corp. To elect S-corp status, you’ll need to fill out a different form, Form 2553, which we’ll go into more detail on later.
Foreign entities
If you are a tax resident of another country, you may want (or even need) to register your business there. Keep in mind that business entities in foreign countries will likely look a bit different (and have different names) than in the US.
These structures not only have unique tax implications in your country of residence, but also in the US. For example, the IRS usually classifies foreign-registered businesses with limited liability protection as corporations by default. In this case, you will need to file Form 5471. Before proceeding, you should always consider and discuss these implications with a tax professional.
When should business owners file Form 8832?
As Form 8832 is voluntary, it does not have a specific deadline. However, the “effective” date you select when filling out the form determines when your new tax status becomes effective.
The effective date for your new tax classification cannot be:
- More than 75 days before you file Form 8832, OR
- More than 12 months after you filed Form 8832
In general, you’ll want to file Form 8832 no later than 75 days after you want your new tax classification to take effect. So if you want to be taxed differently on January 1, you should file Form 8832 by March 15th of the same year.
How to fill out Form 8832
Deciding on the right business entity for you is the hard part. Filling out Form 8832, by comparison, is relatively straightforward.
At the top of the form, you’ll:
- Enter the name of your company, its address, & EIN
- Note: If you don’t have an EIN, you’ll need to get one by completing Form SS-4 before submitting Form 8832
In Part 1 of Form 8832, you’ll:
- Choose your type of election
- Indicate whether the election you’re making is an initial classification or a change of the current classification
- Provide:
- Details on previous entity elections
- The number and names of owners
- Select the entity type
- State where the entity is located
- Select the date on which the change becomes effective
- Note: Remember, this cannot be more than 75 days prior to the date you file Form 8832
- Provide the name & contact information of the person to whom the IRS will reach out if needed
- Sign a consent statement
- Note: All owners of the company must sign and date this statement
Tip:
You can only change tax classifications once every 60 months.
Part 2 of Form 8832 is only for those who want to make the effective election date earlier than 75 days prior to filing. Those to whom it applies will:
- Explain why their election was not filed on time
- Sign a consent statement
- Note: Again, all owners of the company must sign and date this statement if this portion of the form is filled out
Note:
Don’t forget to make a copy of this completed form to attach to your next federal income tax return.
Form 8832 vs. Form 2553
People often confuse Forms 8832 and 2553 because they both allow individuals to change how the IRS classifies and taxes their business. However, Form 8832 allows you to classify your business entity as a corporation for tax purposes, while Form 2553 allows foreign corporations to pay taxes as an S-corp.
References
- Differences Between a Sole Proprietorship and a Partnership
- How are C corporations taxed? Tips on how to avoid double taxation and reduce taxes
- Payroll Tax Rates (2024 Guide)
- How are S corporations taxed? Tips for filing and reducing taxes as a pass-through entity
- LLC vs S Corp: The Difference and Tax Benefits
