Question

Dr. North, a surgeon practicing in Georgia, engaged an Arizona professional corporation consisting of twenty lawyers to represent him in a dispute with a Georgia hospital. West, a member of the law firm, flew to Atlanta and hired local counsel with Dr. North’s approval. West represented Dr. North in two hearings before the hospital and in one court proceeding, also negotiating a compromise between Dr. North and the hospital. The total bill for the law firm’s travel costs and professional services was $21,000, but Dr. North refused to pay $6,000 of it. The law firm brought an action against Dr. North for the balance owed. Dr. North argued that the action should be dismissed because the law firm failed to register as a foreign corporation in accordance with the Georgia Corporation Statute. Will the law firm be prevented from collecting on the contract? Explain.

Explain how te rule of Classification of Corporations: Domestic or Foreign apply to this case.

Answer 1

Classification rule :

When a business entity is created, a determination must be made as to how the entity should be treated for U.S. income tax purposes (its tax classification). Some entities are treated as flow-throughs; their income, losses, and credits flow through to their owners and are subject to tax at the owner level, whether or not actually distributed. Other entities, such as corporations (also known as associations) are subject to income tax at the entity level and then subsequently at the owner (shareholder) level when income is actually distributed to the owner. Prior to the entity classification regulations an entity’s tax classification as a corporation or flow-through entity was determined by multifactor Kintner regulations that enumerated six characteristics of a corporate venture and the classification turned on possession of more or less of the factors. The application of these regulations was theoretically simple, but practically complex because of uncertainty in determining whether an entity possessed any given factor and the rise of limited liability companies and limited liability partnerships (LLCs and LLPs) which narrowed factor distinctions. The IRS announced in Notice 95-14 its intention to simplify the entity classification process. Final entity classification regulations under IRC 7701, also known as Check-the-Box or CTB regulations, were generally effective January 1, 1997 for all domestic and foreign eligible entities. The regulations allow an eligible (i.e., not automatically classified as a corporation) entity to elect to be classified as a corporate (association) or a flow-through (partnership or an entity disregarded from its owner (DRE)) for U.S. income tax purposes. An entity is a deemed corporation if it is so formed under federal or state corporate statutes, or is a type of foreign entity found on a comprehensive list found in Treas. Reg. 301.7701-2(b)(8) (“per se” foreign corporations). These entities are automatically classified as corporations and are not eligible to elect their classification. All other business entities are eligible to elect their classification. If no election is made, a default classification will apply, depending on the number of owners, and for a foreign entity, whether the owners have limited or unlimited liability.