Do it yourself tax planners have been easy prey for the IRS International Tax Auditors. The internet is full of the article on the “check the box” election. It seems simple. Even the IRS makes it seems simple when you read page 4 of the instructions (to Form 8832), but only if you read the instructions as a layman.
When you read the instruction, the IRS uses the term “foreign eligible entity.” Our brains automatically give the words a meaning. However, a tax expert looks up each word independently. Yep, we look up “foreign,” “eligible” and “entity.”
When you dive deep into the regulations, you learn that an “eligible entity” (domestic and foreign) must be a “business entity” (another tax define the term). Anstalts, Stiftungs, and foundations may not be a business entity and thus the check the box election does not apply to them.
Regulation 301. 7701-2 defines Business entities as follows:
“a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301. 7701-3) that is not properly classified as a trust under § 301.7701-4.”
“Not properly classified as a trust” is what destroys Liechtenstein Anstalts Liechtenstein Stiftungs, and Foundations tax classification and tax planning. The IRS ruling at the end of this blog, (in blue ink) highlights the thin edge between a foreign corporation and a foreign trust.
This blog will tell you and your international tax accountant or international tax attorney all that they need to know. The story started almost one hundred years ago with the birth (in 1913) of the income tax law.
The tax law defines a corporation as an entity that a state (or a country) classifies as a corporation and associations that have corporate characteristics. The decision that a character is “corporate” is subjective (an exception applies to per se corporations, more on this link).
It starts in the roaring 20s. During that period, the Treasury Department issued regulations that defined the term “association” broadly enough to include unincorporated entities, such as business trusts.
In Supreme Court case, Morrissey v. Commissioner  decided in 1935, the Supreme Court held that a trust formed to develop and operate golf courses was taxable as an association classified as a corporation (for tax purposes). The Morrissey case is significant because it developed an approach to entity classification that is known as the “resemblance test.”
The Supreme Court considered those features of a trust created to carry on a business enterprise that would make the trust the same as a corporation.
For example, the ability to hold title to the property; centralized management; continuity of life upon the death of an owner; a structure that facilitates the transferability of beneficial interest; and limited liability. The Court determined that the business trust at issue was an association taxable as a corporation because it had the preceding corporate powers.
Of course, the IRS victory was a two-edged sword, and it became a new tax loophole. Tax planners discovered the tax advantages in being taxed as corporations.
Corporations could set up tax-deferred pension plans, which were particularly advantageous at a time when individual tax rates were significantly higher than corporate rates. Professionals that were unable to incorporate under local law formed unincorporated associations that were structured to be taxed as associations under the Morrissey resemblance test.
Beaten up, the IRS found themselves in court trying to undo their Supreme Court victory. in the Ninth Circuit in the 1954 case of United States v. Kintner. In 1954, doctors could not incorporate their business. So a group of California doctors formed a trust to own their medical practice. This allowed them to avoid taxes with the use of “corporate” pension plan.
The Court case determined that an unincorporated professional association formed for the practice of medicine and surgery could be taxed as an association and its pension plan would qualify for tax-deferred benefits under the Code.
The IRS argued against corporate status (taking the opposite position from its Supreme Court case victory). The Kintner court rejected the government’s argument. The court held that the association should be taxed as a corporation.
Because of this defeat, six years later, the IRS issued new regulations. It is these regulations that apply today in defining a business entity versus a trust.
These regulations, which came to be known as the Kintner regulations, adopted an approach to entity classification similar to the resemblance test outlined in Morrissey. The Kintner regulations identified six corporate characteristics.
If an unincorporated organization possessed more corporate than non-corporate characteristics, it was taxable as an association. In distinguishing between a trust and a corporation, characteristics common to both trusts and companies were ignored. Accordingly, just two of the six factors were used to differentiate companies from trusts: (1) the presence of associates; and (2) the objective to carry on business and divide the gains. As you will read below, the courts have consistently ruled that one trust beneficiary can be the “presence of associates.”
The remainder of the blog summarizes the leading court cases and IRS ruling. The point, for you the reader, is to learn you must analyze the laws of the foreign country to decide if the entity and its formation documents create a business entity. The last IRS ruling, at the beginning of this blog, drives home the tax risk. If your tax planning is for a foreign corporation but your entity is a foreign trust or disregarded (because of the foreign laws), you are screwed.
From July through October of 1977, the IRS issued several private letter rulings (PLR) classifying certain foreign organizations with single owners. In these PLRs, the IRS held that the foreign organizations lacked “associates with an objective to conduct business and divide the gain therefrom” and therefore were not a “business entity”.
Even more startling, in some of the PLRs concluded that the organizations could not be classified as trusts. The taxpayer got the worst of all tax results. The foreign organizations were “an integral part” of the sole owner for tax purposes.
Instead, the Tax Court determined that “where there is a single owner, the regulations are not intended to require multiple associates or a sharing of profits among them.” Thus, under Hynes, a trust carrying on business for profit could never be taxable as a trust because it would always possess the two characteristics that distinguish an association from a trust. This of course, would cause chaos in the world of taxation.
In 1992 in the case of Barnette versus IRS Commissioner, the Tax Court considered whether German an entity (organized as a GmbH) should be classified as a separate corporation or disregarded and classified as a branch.
The absence of “associates” and an objective to carry on a business for “joint” profit are common to both one-man corporations and sole proprietorships, so the Tax Court ignored this. In looking at the Kintner regulation, the court held that the GmbH possessed more corporate than non-corporate characteristics and therefore was an association taxable as a corporation (a “business entity”).
In 1973, IRS revenue ruling 73-254 provided that, for purposes of applying the Kintner regulations, the local law of the foreign country would be applied to determine the legal relationships of the members and their interests in the assets.
In 1977, IRS revenue ruling 77-214 applied the four-factor test in the Kintner regulations to determine that a German GmbH was taxable as an association. The decision specifically noted that the GmbH at issue was a juridical person but that, under German law, a GmbH could assume the characteristics of an association or a partnership depending on its memorandum of association. Thus, it could not be automatically treated as a partnership or corporation for federal tax purposes.
In 1988, IRS revenue ruling 88-8  held that all foreign entities are considered unincorporated organizations and therefore must always be classified by application of the four-factor test of the Kintner regulations. This means you must look at the laws for the foreign country and make a determination.
IRS revenue ruling 88-8 involved the classification a U.K. unlimited company. The entity was formed under Great Britain’s “corporation” statute. Nevertheless, the ruling held that the entity was not a corporation for U.S. tax law. It lacked the corporate characteristics of limited liability and free transferability of interests.
In 2009, the IRS issued a legal opinion (IRS Generic Legal Advice AM 2009-012) of this issue (see the full opinion on this blog).
Here is what the IRS stated about Liechtenstein Anstalts
Based upon the information submitted, we believe that, subject to the facts and circumstances of each situation, Liechtenstein Anstalts are not properly treated as trusts under § 301.7701-4(a) of the regulations because, in most cases, their primary purpose is to actively carry on business activities. Further, Liechtenstein Anstalts are not subject to special treatment under the Code.
Therefore, Liechtenstein Anstalts are classified as “business entities” under § 301.7701-2(a). IRS’s Opinion with the reminder that their opinion would vary case by case. (Author note: Please note that the IRS is telling to look at the foreign law).
Here is what the IRS stated in Liechtenstein Stiftungs
Based on the information submitted, we believe that, subject to the facts and circumstances of each situation, Liechtenstein Stiftungs are properly treated as trusts under § 301.7701-4(a) of the regulations. (Author note: Here the IRS has the opposite conclusion but in the same legal opinion) In most cases, the Stiftung’s primary purpose is to protect or conserve the property transferred to the Stiftung for the Stiftung’s beneficiaries and is usually not established primarily for actively carrying on business activities.
However, it is important to note that if the facts and circumstances indicate in a particular case that a Stiftung was established primarily for commercial purposes as opposed to the purpose of protecting or conserving property on behalf of the beneficiaries, the Stiftung in such case may be properly classified as a business entity under § 301.7701-2(a).
Accordingly, it is important to analyze the facts and circumstances of each case to determine whether a particular Stiftung was established to protect and conserve property of the Stiftung or, was created as a device to carry on a trade or business.
 See Art. 1502, Regulation No. 45, T.D. 3146 (1920) (associations and joint stock companies include certain common law trusts and other organizations that do business in an organized capacity); Art. 1504, Regulation No. 65, T.D. 3640 (1924) (reflecting decision of Hecht v. Malley, 265 U.S. 144 (1924), by treating operating trusts as associations, regardless of degree of beneficiaries’ control, where beneficiaries’ activities included more than collecting funds and making payments to beneficiaries); Art. 21-23, Regulation 64, T.D. 4575 (1935) (trust treated as an association if it is an arrangement conducted for profit where capital is supplied by beneficiaries and the trustees are in effect the managers of the arrangement, whether or not beneficiaries appoint or control trustees).
 296 U.S. 344 (1935).
 Id. at 359.
 Id. at 360.
 See Kurzner v. United States, 413 F.2d 97, 101 (5th Cir. 1969). See also Hobbs; supra note 334, at 481-83.
 216 F.2d 418 (9th Cir. 1954).
 See PLR 77-43-060 (July 28, 1977) (classifying a German GmbH); PLR 77-43-077 (July 29, 1977) (classifying a French societe a responsabilite limitee); PLR 7747-083 (Aug. 26, 1977) (classifying a German GmbH); PLR 77-48-038 (Aug. 31, 1977) (classifying a German limited liability company); PLR 78-02-012 (Oct. 11, 1977) (classifying a Brazilian limited liability company).
 See PLR 77-43-060; PLR 77-48-038.
 Id. at 1280.
 Id. The Tax Court determined that because the trust clearly had five of the six corporate characteristics, it would be taxable as an association. Id. at 1286. See General Counsel Memorandum 38,707 (May 1, 1981) (IRS will follow Hynes).
 T.C. Memo. 1992-371, 63 TCM (CCH) 3201 (1992).
 63 TCM at 3201-12.
 1988-1 C.B. 403.