The Tax Court decided 11–4 that an S election was automatically terminated because the corporation’s sole shareholder was a Roth IRA. The case was said to be a test case for a number of similar ones before the court.
Taproot Administrative Services Inc., a Nevada corporation, was fully owned by a custodial Roth IRA for the benefit of Paul DiMundo. Taproot made an S corporation election in 2003. The IRS issued a notice of deficiency, saying Taproot was not an S corporation because it was owned by an ineligible shareholder and should be taxed as a C corporation.
Allowable shareholders under IRC § 1361 are individuals, estates, certain exempt organizations and certain trusts: grantor trusts, pre-mortem grantor trusts for two years after the grantor’s death, postmortem trusts that receive stock under a will (but only for two years following the transfer), voting trusts and “electing small business trusts.” For years after the year at issue, eligible shareholders also include banks whose stock is owned by an IRA or Roth IRA. Taproot claimed that because the Roth IRA was a custodial account, it was a qualified trust for purposes of being an S corporation shareholder.
The Tax Court cited Revenue Ruling 92-73, which holds that a traditional IRA is not a grantor trust eligible to be considered an S corporation shareholder because, unlike a grantor trust, its income is not currently taxed to the beneficiary. The same is true of Roth IRAs, the court said.
Judge Mark V. Holmes was joined by three other judges in a dissenting opinion agreeing with Taproot’s alternative argument that DiMundo, not the Roth IRA, should be considered the shareholder under Treas. Reg. § 1.1361-1(e)(1), which states, “The person for whom stock of a corporation is held by a nominee, guardian, custodian, or an agent is considered to be the shareholder of the corporation.” In this case, a trust company, First Trust Co. of Onega, held the stock as custodian for DiMundo. In a supplemental opinion concurring with the majority, Judge James S. Halpern acknowledged Holmes’ reading of the regulation for other types of custodial accounts, but wrote that because of an IRA’s special tax treatment, regarding it in such a fashion “utterly subverts the rationale for the attribution rule in the regulation.”
Holmes noted that the case “and its companion cases are only a few of nearly a hundred pending before the court.” Fourteen of those cases in his division had settled with the IRS “and decided to make Taproot the test case.”
Taproot Administrative Services Inc. v. Commissioner , 133 TC no. 9
Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor
of Accounting and director, MTA Program, Culverhouse School of
Accounting, University of Alabama, Tuscaloosa.