The IRS uses the information entered on the form to establish the entity's filing and reporting requirements for federal tax purposes.
The initial regulations were unclear on this point, so the IRS issued Revenue Rulings 99-5 and 99–6 in 1999 to address questions surrounding the conversion of an LLC to a partnership and vice versa.
The possibility that the check-the-box rules would greatly expand the potential for such strategies had been pointed out prior to implementation, and at one point some commentators suggested disallowing foreign entities from electing their classification at all; however, in the end, the IRS, while acknowledging such concerns, issued regulations which gave foreign and domestic entities largely similar powers to elect their own classification.
[8][10] This arrangement may be used to shift income between the two non-American jurisdictions and avoid local taxes in one or the other, e.g. through thin capitalization.
[9] Another category of US taxpayers who benefit from check-the-box regulations consists of US flow-through entities (S corporations and partnerships) with foreign subsidiaries.
However, this treatment is only available for dividends from corporations in certain countries, and is set to sunset in 2010 under the Tax Increase Prevention and Reconciliation Act of 2005.
The US holding company receives a loan from its home country parent which it invests in a US operating subsidiary; the US holding company receives dividends from the US operation subsidiary and pays interest to the non-US parent.
[9] The "check-the-box" regulations (Treasury Decision 8697) were adopted in 1996 in order to simplify the issue of entity classification.
[15] However, various tax professionals opposed the changes, arguing that the threshold for defining an extraordinary transaction was far too low, and that existing internal revenue regulations, as well as common law doctrines such as the principle of substance over form and the step transaction doctrine, were already sufficient to combat any abuses of the check-the-box rules.
Except in cases of U.S. 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.The proposal was eventually dropped again due to criticism from businesses, and it was not included again in the 2011 budget proposal either.