LLC Classification Problems and Form 8832: When Your LLC Is Not What You Think

"LLC" is not a tax classification. The IRS has no LLC tax return. When you form a limited liability company, federal tax law treats it as one of three things: a partnership, an entity disregarded as separate from its owner, or a corporation. Which one depends on how many owners it has and whether anyone filed an election.

A surprising number of LLCs have been filing returns for years under the wrong classification. Sometimes nobody notices. Sometimes the IRS sends penalty notices for returns the owners never knew they were supposed to file.

The default rules

Treas. Reg. 301.7701-3 governs the classification of "eligible entities," which includes domestic LLCs. Under Treas. Reg. 301.7701-3(b)(1), unless the entity elects otherwise, a domestic eligible entity is:

• A partnership if it has two or more members, or
• Disregarded as an entity separate from its owner if it has a single owner.

A partnership files Form 1065 and issues Schedules K-1. A disregarded single member LLC owned by an individual reports its income on the owner's return. IRM 5.1.21.13.3 notes that the individual owner of a disregarded entity reports the LLC's income and expenses on the appropriate schedules of the owner's Form 1040.

Under Treas. Reg. 301.7701-3(a), an eligible entity with two or more members can elect to be a corporation (an "association") or a partnership. A single owner entity can elect to be a corporation or a disregarded entity. Elections are needed only to depart from the default or to change classification.

How Form 8832 elections work

An eligible entity elects its classification by filing Form 8832, Entity Classification Election. Key rules from Treas. Reg. 301.7701-3(c):

• Effective date window. The effective date cannot be more than 75 days before the date the election is filed, and cannot be more than 12 months after. An election that specifies an earlier date is effective 75 days before filing.
• 60-month limitation. Once an entity elects to change its classification, it generally cannot change by election again during the 60 months after the effective date. An election by a newly formed entity effective on the date of formation is not considered a change for this purpose.
• Signatures. The election must be signed by each owner at the time of filing, or by an authorized officer, manager, or member. For a retroactive election, owners during the retroactive period who are no longer owners must also sign.
• EIN required. The regulation says the election will not be accepted unless the form includes the entity's taxpayer identifying number.
• Attach a copy. A copy of Form 8832 must be attached to the entity's return for the year of the election. Failing to attach it does not invalidate an otherwise valid election, but penalties may apply.

The Form 8832 instructions also say the service center should generally notify the entity within 60 days of filing whether the election was accepted, and they list acceptable proof of filing, such as a timely postmarked certified or registered mail receipt or an IRS acceptance letter. Keep that letter. You will want it someday.

S corporation elections are different

An LLC that wants S corporation treatment generally does not file Form 8832 at all. Under Treas. Reg. 301.7701-3(c)(1)(v)(C), an eligible entity that timely elects S status under IRC 1362(a) is treated as having elected to be an association, provided it meets the other small business corporation requirements. The Form 2553 does double duty.

Where LLC classification goes wrong

The S election that was never accepted

The owners believe the LLC is an S corporation and file Form 1120-S every year. But Form 2553 was never filed, was filed late, or was never accepted. Without a valid election, a multi-member LLC is still a partnership by default, and a partnership's required return is Form 1065, not Form 1120-S. IRM 5.1.21.4.1 notes that an entity that filed its S election late, and intended to be treated as an association, may be eligible for relief under Rev. Proc. 2013-30, which the IRS later amplified in Rev. Proc. 2022-19. Our guide on late S corporation election relief covers that process.

The single member LLC that added a member

Treas. Reg. 301.7701-3(f)(2) says a disregarded single member entity is classified as a partnership when it has more than one member, and a partnership becomes disregarded when its membership drops to one. No election is filed. It just happens. If a second owner came in mid-year, the LLC may have owed a Form 1065 starting that day.

The husband and wife LLC

Two spouses who own an LLC together are two members, so the default classification is a partnership. IRM 5.1.21.10.2 describes Rev. Proc. 2002-69, under which the IRS will respect the spouses' choice of partnership or disregarded entity treatment where the LLC is owned solely by the spouses as community property under the laws of a state, foreign country, or U.S. possession. Outside that community property rule, a spouse-owned LLC is a two member entity like any other. For more, see this discussion of husband and wife LLCs and partnership returns.

The corporate election nobody remembers

Someone filed Form 8832 years ago to treat the LLC as a corporation, and later preparers filed partnership returns. Under Treas. Reg. 301.7701-3(c)(1)(iv), the 60-month rule may also limit how fast you can switch back.

Why the wrong classification costs money

The biggest exposure is usually filing penalties. If the LLC was a partnership and no Form 1065 was filed, IRC 6698 imposes a penalty assessed against the partnership for each month (up to 12 months) the failure continues, multiplied by the number of partners, unless the failure was due to reasonable cause. A failed S election that leaves Form 1120-S as the only return can produce the same problem from a different direction. Our page on the Form 1065 late filing penalty explains how that penalty is computed and challenged.

Classification changes also have income tax consequences. Treas. Reg. 301.7701-3(g) describes the deemed transactions. For example, a partnership electing to be an association is deemed to contribute all of its assets and liabilities to the association for stock and then liquidate by distributing the stock to the partners. An association electing partnership status is deemed to liquidate and the shareholders are deemed to contribute the assets to a new partnership. These deemed steps can be taxable.

Late election relief under Rev. Proc. 2009-41

If you missed the 75-day window, you may not be stuck. The Form 8832 instructions describe late classification relief under Rev. Proc. 2009-41, 2009-39 I.R.B. 439. Under those instructions, an entity may qualify if each of the following is met:

1. The entity failed to obtain the requested classification solely because Form 8832 was not filed timely.
2. Either the due date of the first year's return has not passed, or the entity (and affected persons) timely filed all required returns consistent with the requested classification, or filed them within 6 months after the due date excluding extensions, and no inconsistent returns were filed.
3. The entity has reasonable cause for the late election.
4. Three years and 75 days from the requested effective date have not passed.

Relief is requested by filing Form 8832 with the late classification relief box checked and Part II completed, including an explanation and a declaration signed by an authorized representative and each affected person. If Rev. Proc. 2009-41 does not apply, the instructions say the entity may request a private letter ruling and pay a user fee.

The current Form 8832 is the December 2013 revision, and the IRS's Form 8832 page still links to Rev. Proc. 2009-41. Mailing addresses have changed since the form was printed, so check the IRS update page attached to the form before mailing.

A practical review

• Find every Form 8832, Form 2553, and IRS acceptance letter for the entity.
• Build an ownership history showing the number of members on every date.
• Compare the classification the law says you have to the returns you actually filed.
• Identify every unfiled return and the penalty exposure for each.
• Decide whether late election relief is available, or whether the cleaner answer is to file the returns that match your actual classification. Our page on catching up unfiled 1065 and 1120-S returns covers that path.

If you are not sure what your LLC is for tax purposes, call the Law Offices of Darrin T. Mish, P.A. in Tampa at 813-229-7100. Your LLC already has a classification. The only question is whether your returns agree with it.