Everything you need to know about Form 8832
Taxes. They touch everybody and every company.
And, as a business owner, you probably dream about finding ways to reduce your tax liabilities. And, especially for cannabis companies because of Section 280E of the Internal Revenue Code (“IRC 280E”).
First, what is IRC 280E?
One of the most frustrating tax law sections for cannabis companies, IRC 280E forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of substances on Schedule I or II of the Controlled Substances Act.
The IRS has subsequently applied IRC 280E to state-legal cannabis businesses, since cannabis remains on Schedule I as a controlled substance. So, if your business touches the plant in any way, you’re subject to IRC 280E.
Most cannabis companies have high tax bills because of the negative impacts of IRC 280E. These negative impacts are “passed through” to the owners of a business when they are incorporated as a partnership or an LLC. Now, there are ways to legally mitigate the impacts of IRC 280E, but that’s for another discussion.
If your company is set up as a single-member LLC or a multi-member LLC, the tax liability passes to the individual members. And, carries the potential for a large personal tax liability. Some companies make special distributions to cover the owner’s or partners’ tax liability passed through to them from the company. But, the tax liability is still on the individual(s)!
So, another option is to elect to be taxed as a C-corporation. That way, the tax liability is paid by the company rather than being passed through to the individual members/partners. And, typically this tax election is made by filing IRS Form 8832 to change your business’s tax classification.
What is IRS Form 8832?
IRS Form 8832, Entity Classification Election, is a form certain businesses can use (which we will get to later) to elect or change how they are classified for federal tax purposes.
All businesses receive a default tax classification, which can result in paying more business taxes than necessary. If you’re eligible to use the entity classification election form, you can change your tax election status and potentially lower your personal tax liability.
A Form 8832 is a voluntary election form you file with the IRS that lets them know you want your company to be taxed as a C-corporation. And, doing so alleviates the personal tax liability that comes with a single-member LLC (taxed as a sole proprietorship by default) or a multi-member LLC (taxed as a partnership by default).
Which businesses can use Form 8832?
Not every type of business can use Form 8832 to change their business’s tax classification. The following businesses are eligible:
These entities can use Form 8832 to elect to be taxed as a C-corporation, partnership, or sole proprietorship.
If you’re currently an LLC taxed as a corporation, you can also use Form 8832 to revert back to a previous tax classification.
Eligible businesses that don’t fill out the form will be taxed based on their default tax status.
► Pro Tip: If you’re happy with your current or default tax classification you don’t need to fill out Form 8832.
And, keep in mind that your business can only change its tax classification once every five years.
Who is not eligible to file Form 8832?
Sole proprietorships (as opposed to single-member LLCs taxed as sole proprietorships) are not eligible to file a Form 8832 election.
If your business is a corporation that wants to be taxed as an LLC, don’t file Form 8832. Instead, contact your Secretary of State to find out how to convert your corporation.
Additionally, if your business is an LLC that wants to be taxed as an S Corp, you’ll file Form 2553 instead of Form 8832.
Why is Form 8832 Important?
The bottom line: Form 8832 can affect your bottom line.
If you don’t fill out Form 8832, your business will be given a default tax classification. And, you may end up paying more business taxes than you really need to. If you choose wisely changing your tax election status can potentially save you thousands of dollars per year. Why?
Well, for one, members of LLCs and partnerships are considered self-employed individuals — remember that “pass through” thing? As such, they generally carry a higher tax liability than corporations. These higher tax liabilities are usually in the form of self-employment taxes you pay rather than the portion of FICA taxes that a typical company would pay for their employees.
Add to that, individual tax rates vary depending on your taxable income, including the income from the business. Remember that IRC 280E thing we talked about before? Well, that only makes your personal tax liability higher.
So, while individual tax rates can be as high as 37 percent, corporations are taxed at a flat rate of 21 percent. This creates a huge opportunity to save tax dollars!
Just keep in mind that how one partner is taxed in a partnership applies to all partners. So, it’s a good idea to discuss the personal tax strategies with all your partners before you make an entity election change.
When Is Form 8832 Due?
Often, tax deadlines for businesses are strict. But because Form 8832 isn’t mandatory, it doesn’t have a deadline, per se. You can file it at any point in the lifetime of an eligible business.
Whether you operate a brand-new company or one that’s been around for decades, you can still elect to change its entity classification.
There are some basic rules, though. When filing Form 8832, you can include a date that the change will take effect. This date has to fit within a certain timeframe, namely:
An accountant can help you choose the ideal effective date to put on your entity classification election form. There’s often some strategy involved, so make the right call to help optimize your taxes.
Once the IRS accepts your entity election, your new classification will remain in place indefinitely. There’s no need to file Form 8832 a second time unless you want to change your entity classification again.
Keep in mind that your business can only change its tax classification once every five years
And as a reminder, in most cases, you can only change your classification once every five years, so you may have to wait. But there are a few exceptions, so consult your accountant to see if you can make a new election before the five years are up.
After Filing, What Happens Next?
Once you’ve sent the form in, all you have to do is wait for a reply. The IRS should send you a letter either accepting or denying your request to change your status within 60 days. If you haven’t heard back after 60 days, you can call the IRS or send a letter to the service center to check on the status of your form.
And that’s it! You’re all set. If your entity classification is accepted, just make sure to attach a copy of the form to your US federal income tax return for the first year it’s effective, and you’re good to go.
Want to learn more? Speak with us about how we can help you pay only the taxes you legally owe and not a penny more!