paystubmakr.com presents the article Unincorporated Associations
Although §7701(a)(3) states that the term corporation includes associations, it does not define an association. The Supreme Court, however, has defined an association as “a body of people united with not a charter, but upon the ways and forms used by incorporated bodies for the prosecution of some common operation” (Hecht v. Malley, (1924, S. Ct.) 265 US 144).
Unincorporated associations are popular business forms for tax-exempt organizations of the mutual benefit genre, while most public benefit organizations tend to opt for the traditional corporate structure.
For federal income tax purposes, unincorporated associations that are taxable entities are generally treated as corporations.
Quote from California Forms & Instructions 100
“An association will have taxes as a corporation if it resembles a corporation than any other organization, that is, it has more corporate characteristics than noncorporate characteristics, However, if the articles of association are properly executed, and if it is desirable to the associates, the association can be made to parallel a partnership so closely that it would be difficult to point out any obvious differences of structure.”
Corporate Treatment
Organizations that are unincorporated and have certain corporate characteristics are classified as associations and taxed as corporations. These organizations must have associates and be organized to carry on business and divide any gains.
They must also have a majority of the following characteristics:
(1) Continuity of life,
(2) Centralization of management,
(3) Limited liability, and
(4) Free transferability of interests.
An organization will be treated as an association if its corporate characteristics make it more nearly resemble a corporation than a partnership or trust. The facts in each case determine whether or not these characteristics are present (Reg. §301.7701-2(a)(1)).
Corporation Defined
What precisely is a corporation? However simple this question may seem, there is a bit more to it than mere compliance with state laws. The fact that an entity was organized and operated in the strictest compliance with state laws may not impress either the IRS or the courts. The other side of the coin is that an organization that is not formed as a corporation may be taxed as a corporation by the IRS under the association rules.
Section 7701(a)(3) places a very broad definition upon the term “corporation.” This is defined to include “associations, joint stock companies, and insurance companies.” 1-14Effect of State Laws
The legality of an organization under state laws is not a determining factor. In Morrissey v. Commissioner, 36-1 USTC 9020, 16 AFTR 1274, 56 S.Ct. 289 (USSC 1936), an organization that was a business trust under state law was deemed to be an association for federal income tax purposes, and therefore, was taxable as a corporation. Furthermore, in the U.S. v. Kintner, 54-2 USTC 9626, 47 AFTR 995, 216 F.2d 418 (9th Cir. 1954), a partnership of physicians was deemed to be an association (and likewise, taxable as a corporation), even though applicable state law prohibited the practice of medicine in the corporate form.
Corporate Characteristics
Regulation §301.7701-2(a) provides a checklist of “corporate characteristics.” The number of corporate characteristics present in the organization will determine whether or not it is to be treated as an association for federal income tax purposes. These corporate characteristics are as follows:
(1) Associates;
(2) An objective to carry on a business or profession and to divide the profits from that place;
(3) Continuity of life;
(4) Centralized management;
(5) Limited liability to the associates; and
(6) Free transferability of interests.
The Regulations provide that for an unincorporated organization to be classified as an association for federal income tax purposes, it must possess more corporate characteristics than non-corporate characteristics. Characteristics which are common to both corporate and non-corporate organizations shall be disregarded in making the determination.
Partnership Determinations
In determining whether or not a partnership will be treated as an association for federal income tax purposes, the first two corporate characteristics listed above are disregarded. The determination is based on items 3 through 6.
Partnership taxation in the United States
Generally, if a partnership possesses three or more of these characteristics, it will be treated as an association, and taxed like a corporation. Trust Determinations In the case of a trust, the situation would be reversed. Items 3 through 6 would be disregarded and items 1 and 2 would be considered in making the determination.
Professional Associations
Organizations of doctors, lawyers, and other professional people organized under state professional association acts are generally recognized as corporations for federal income tax purposes. A professional service organization must be both organized and operated as a corporation to be classified as one. All of the states and the District of Columbia have professional association acts.
Check-The-Box Regulations
The IRS has released final regulations for entity classification (TD 8697), commonly known as the check-the-box regulations. The final rules allow entities that are not required to be classified as corporations (e.g., entities that have complied with the formal state law requirements to be organized as “corporations”) to elect to be taxed as partnerships or corporations. This simplified regime, which applies to domestic as well as foreign business entities, replaces the existing fact-intensive classification regulations that are based on the historical differences between partnerships and corporations under local law (i.e., the “Kintner regs.” under §301.7701).
Among those entities classified as corporations under the final regulations are:
(1) Entities denominated as corporations under applicable law,
(2) Associations,
(3) Joint-stock companies,
(4) Insurance companies,
(5) Organizations conducting certain banking activities,
(6) Organizations wholly owned by a state, and
(7) Organizations are taxable under provisions of the Code other than §7701(a)(3).
The regulations also contain a list of foreign entities that are treated as per S corporation. However, any entity that is not required by the IRS “the regulations to be treated as a corporation is an eligible entity and may choose its classification.” Also, an eligible entity with two or more members can be classified as either a partnership or a corporation. A single member entity can be classified as a corporation or can be disregarded as an entity separate from its owner. The final regulations have default classifications for eligible entities that will provide most entities with the classification they would otherwise choose. Therefore, in many cases, an actual election will not need to be filed. For eligible domestic entities, the regulations adopt a passthrough default, and the default for foreign eligible entities is based on whether members of the entity have limited liability. A foreign entity is classified as a partnership if it has two or more members and one of them does not have limited liability. A single-member entity whose owner does not have limited liability will be disregarded as an entity separate from that owner. An existing entity’s “default classification” status is the classification claimed by the entity immediately before the effective date of the regulations. An eligible entity’s election of its classification may be made onForm 8832, Entity Classification Election.
The final regulations are effective as of Jan. 1, 1997. However, under a special transition rule for existing entities, the IRS will not challenge the prior classification of an existing eligible entity or an existing entity on the per se list for periods.
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