When forming a business abroad as a US expat, there are several important factors to consider. Chief among them is selecting the business entity to establish – this may later inform how you file IRS Form 8832: Entity Classification Election. Filing Form 8832 establishes how the IRS classifies and taxes your foreign business. That said, you may not need to file this form at all – more on that below.
Classifying a business entity is done via Form 8832, where business owners can effectively determine their US tax status by electing to be taxed as a certain type of entity (e.g., sole proprietorship or C corporation). In order for the classification to be accepted, however, the foreign business structure must “match” the entity election. An incorrect election may lead to unexpected IRS tax notices.
Below, we parse the intricacies of Form 8832, covering topics such as eligibility, effective dates, election relief, and the role of tax advisors in filing the form within the 75-day window to ensure proper tax classification.
For your reference: Here is the IRS Form 8832 PDF.
Who decides how to classify a business entity?
The choice of business structure ultimately lies with the business owner(s) and largely depends on the country where your company is formed.1 As a US expat, you may well be familiar with classic US business entities for small businesses, such as sole proprietorships, partnerships, corporations, and limited liability companies. These structures will likely look a bit different (and have different names) in a foreign country.
Additionally, you will want to consider the tax implications of creating your business in a foreign country. Selecting the entity you create will likely involve a cross-border analysis of the tax implications in both the US and the foreign country, which will need to be fully understood and strategically reconciled prior to proceeding.
Once you have successfully formed your foreign company, the next step is to determine how you want the company to be taxed for US tax purposes. This decision should be made in consultation with a US expat tax professional and foreign tax professional to ensure the best outcome for your business.
What is Form 8832?
Form 8832: Entity Classification Election essentially lets you choose how you want your business to be taxed by the IRS. However, this selection must be substantiated by the structure of the foreign business. Let’s dig in a bit deeper to understand how the IRS assesses entity elections made on Form 8832.
US federal taxation of your foreign company will initially depend on how many owners it has.
One-owner businesses can be taxed as either:
- A sole proprietorship (default tax classification) or
- A corporation.
When someone has limited liability protection with respect to their foreign company, the entity is by default treated as a corporation. In the absence of an election, the business will attract a 5471.
Companies with two or more owners can be taxed as either:
- A partnership (default tax classification) or
- A corporation.
Is it necessary to file Form 8832?
The IRS has default modes of taxing foreign entities when reported on US expat returns. If the default classification is in your best interest, you do not need to file the Business Entity Election. It is when you want your foreign company to be taxed differently than the IRS default tax classification that you need to complete Form 8832.
Let’s look at an example to put the above information into context.
Fabrice Amari, a US citizen, formed an impresa individuale in Italy.2 He resides in Italy and he is the owner of the company. He has no business partners. By default, the IRS will classify his company as a sole proprietorship.
If this classification is in his best financial interest, he does not need to file Form 8832. However, if Fabrice and his expat tax accountants determine that it is in his best interest to be classified as a corporation, he would complete Form 8832.
Form 8832 vs. Form 2553
Forms 8832 and 2553 are often confused because their base function is to establish how the IRS classifies and taxes a foreign entity. Below, we clarify the difference:
- Form 8832: allows you to change your tax classification,3 while
- Form 2553: allows a corporation to be taxed as an S-corporation.4
Essentially, Form 2553 is an administrative layer necessary to add onto US expat tax filings that wish to be classified specifically as an S-corporation. The reason for this is based on an IRS technicality: only domestic corporations can be S-corporations.
Given that sole proprietorships are one of the most common and sensible business entities for small business owners, we return now to our example to illustrate the best path forward for a US expat with a sole proprietorship who wishes to be taxed as an S-corp.
If Fabrice wants his Italian company to be taxed in the US as an S-corporation, he’ll need to register his company in the US. He can then communicate his wish to be taxed as an S-corp to the IRS via Form 2553.
When should business owners file to change their company’s tax status?
Form 8832 is a voluntary form that 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.
As with all things tax-related, there are rules and strategies to be mindful of when selecting the effective date for your company’s tax status. For example, the effective date for your new tax classification cannot be:
- More than 75 days before you file Form 8832 or
- More than one year after you filed Form 8832.
Instructions for Form 8832
At the top of the form, you’ll enter the name of your foreign company, its address, and EIN. If you don’t have an EIN, you’ll need to get one by completing Form SS-4 before submitting Form 8832.
Next, you’ll enter the type of entity you want to change to.
Then, you’ll select the date that the change is effective. As noted above, this cannot be more than 75 days before you file Form 8832.
Part 1 of Form 8832 includes a set of yes/no questions. The first required information is whether you’re making an initial classification or changing the current classification.
You can only change tax classifications once every 60 months.
Part 1 ends with a Consent Statement, which all owners of the foreign company must sign.
Part 2 of Form 8832 deals with Late Election Relief. This part is only necessary if you want to set an effective date earlier than the stipulated 75 days before the filing date.
Form 8832 deadline
In general, you’ll want to file Form 8832 no later than 75 days after you want your new tax classification to take effect.
Essentially, if you want to be taxed differently on January 1, you want to file Form 8832 by March 16th of the same year.