The Ninth Circuit, affirming the Tax Court, held that a corporation whose sole shareholder was a Roth IRA was not a valid S corporation when it was created in 2003 (Taproot Administrative Services, Inc., No. 10-70892 (9th Cir. 3/21/12), aff’g 133 T.C. 202 (2009)). The taxpayer who established the Roth IRA argued that he, as the individual beneficiary of the IRA, should be treated as the S corporation shareholder, or, alternatively, the IRA should be treated similarly to a grantor trust or a qualified subchapter S trust (QSST), permitted shareholders for S corporation purposes.
In rejecting the taxpayer’s argument that the IRA should be treated as a permitted trust under the S corporation eligibility rules, the Ninth Circuit noted that unlike grantor trusts and QSSTs, which are both taxed currently on their income, IRAs and Roth IRAs are subject to deferred taxation on current income and thus are incompatible with the S corporation taxation rules. The court mentioned approvingly Rev. Rul. 92-73, the only IRS statement on the issue, which specifically prohibits IRAs as S corporation shareholders (the ruling was issued before Roth IRAs were enacted in 1997). The court also cited, as evidence that IRAs were not intended to be permitted S corporation shareholders, the 2004 enactment of the rule permitting a narrow class of banks with IRA shareholders to elect S status, which would not have been necessary if IRAs were already permitted shareholders.
The most interesting argument the taxpayer made on appeal was that his Roth IRA was indistinguishable from a custodial account, which is a permitted S corporation shareholder under Regs. Sec. 1.1361-1(e) because it is the equivalent of a “nominee, guardian, custodian, or an agent.” Under this reasoning, the Roth IRA was a custodial account for its individual owner, and the owner of the IRA was the S corporation’s actual owner. But the court concluded that the type of custodial account envisioned by the regulation was one in which the ultimate beneficiary would be currently taxed on the S corporation’s income, not one in which the taxation of the income would be deferred.
—Sally P. Schreiber (firstname.lastname@example.org) is a JofA senior editor.
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