Academic

Leandra Lederman on Field's Check-the-Box

By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring

Heather Field?s thoughtful paper, Checking In on "Check-the-Box," is a timely analysis of the check-the-box regulations, which have been in place for over a decade now. It compares the check-the-box rules to the corporate resemblance test of the former "Kintner" regulations; analyzes the pros and cons of the elective regime from a tax policy perspective; and considers the effects of the mechanics of the election itself. The paper explicitly sets aside the question of the rationality of retaining multiple regimes for taxing businesses, under which some entities are required to be taxed under Subchapter C?resulting, at least in theory, in taxation at both the entity and investor levels?while others have an explicit option to elect pass-through treatment and thus a single level of taxation. The paper concludes, however, that most of the weaknesses identified in the examination of the check-the-box regulations actually result from the existence of multiple regimes for taxing businesses. As discussed below, while the detailed analysis is very informative, this concluding insight might be expanded a bit to provide a broader context for the paper.

The paper starts with helpful background of the corporate resemblance test under the Kintner regulations" that the check-the-box regulations replaced. It traces the development of the LLC and the IRS?s tax treatment of it. A minor comment on this Part is that I think a bit more context could improve the discussion of the advent of the LLC?it might help to point out that the LLC was developed in light of the Kinter regs to be a vehicle that obtained pass-through treatment for tax purposes, while retaining limited liability. As the paper discusses, the advent of the LLC was a big part of the reason Treasury abandoned the corporate resemblance test in favor of a purely elective regime.

Part III of the paper analyzes the pros and cons of check-the-box. Some of the benefits and detriments have existed since the regulations were promulgated. However, the look back shows that the regulations have been amended more than ten times since they were promulgated in 1997, and the IRS has also issued numerous rulings related to entity classification issues. The paper argues that this is suggestive of complexity created by the regulations. This is an interesting argument that could be made stronger by including a baseline for comparison, such as how many times the Kintner regulations were amended in the eleven years before they were repealed and approximately how many rulings on entity classification were issued during that period. That is, how much complexity is due to check-the-box, and how much is endemic to having a regime that taxes different legal entities differently? Also, in the discussion of how the regulations apply to foreign entities, it might help to describe the abuses in a bit more detail, to clarify what tax benefits foreign entities obtain that they could not have gotten under the Kintner regs, for example.

Part III?s assessment of the fiscal impact of check-the-box in light of the decade or so of experience with it is an interesting idea?do corporate tax receipts suggest that check-the-box really did just formalize an election that already existed in practice? The paper makes enterprising use of government data about check-the-box elections made from 1997 on; it appears that the IRS shared some unpublished data, allowing a unique look at its experience with check-the-box. This approach is promising, and may suggest lines for future research that would help isolate the impact of check-the-box on corporate tax receipts. For example, the statistics show that corporate income tax revenue declined slightly in the late 1990s and early 2000s as a percentage of total tax revenue, before rebounding again in the last few years. This may partly reflect the corporate tax shelter phenomenon, and it might be possible to control for that using regression analysis.

Part IV of the paper examines the mechanics of the check-the-box election itself. The first section of this Part recalled the earlier discussion of the pros and cons of having an explicit election, and might be effectively consolidated with that discussion. The remainder of this Part examines the threshold requirements of the election (such as the existence of a separate entity that is a business entity). The paper makes the point that the "entity" requirement is logical because the check-the-box regulations only address entities; a minor comment in this regard is that it is at least theoretically possible for businesses that are not entities to be subject to a regime like check-the-box. The Treasury Department?s 1992 Comprehensive Business Income Tax proposal, which would have applied to sole proprietorships as well as business entities, comes to mind as something of an analogy.

Because one of the threshold requirements of check-the-box is that the entity not be incorporated under state law, Part IV includes an examination of the theories justifying separate corporate taxation. It discusses and generally dismisses a number of arguments justifying that tax. It also considers why most publicly traded partnerships are statutorily taxed as corporations. This discussion of the multitude of taxing regimes for businesses struck me as a core part of the paper. In fact, while reading the paper, I kept thinking about this issue. Although the paper expressly sets aside the question of how to rationalize the various systems of taxation, it considers whether the application of different regimes to different entities can be reconciled and concludes that it cannot. The analysis in the paper, in the context of this background of multiple taxing regimes, suggested to me that the check-the-box regulations not only made explicit the implicit election the well-advised could accomplish under the Kintner regs, they also helped reduce pressure to reconsider the corporate double tax. The current system of Subchapters C, S, and K existing side-by-side, with various rules for eligibility and elections available for some entities but not others, is probably not what we would have if we were starting from scratch. There seems to be a path-dependent nature to the rules governing the taxation of businesses: The check-the-box regulations may be one step in a multi-stage process that started with artificially bright lines between entities and aggregates but that has evolved to reflect both the flexibility of organizational structure existing on the ground and the demand, particularly by small businesses, for structures that don?t bear two levels of federal income tax.

Overall, I thought this well-written and well-researched paper provided an interesting and thorough retrospective on the check-the-box regulations. The detailed consideration of the costs and benefits of the regulations allowed isolation of the effects of an explicit election itself from the substantive changes from the Kintner regulations, including the creation of the "disregarded entity" category. The topic also connects nicely with the literature on multiple tax regimes, which could allow for a broader "hook" for the paper, if that isn?t inconsistent with its goals. I?ll follow up with a few more comments privately.

Full post as published by Conglomerate on August 04, 2008 (boomark / email).