Roth IRA an Ineligible S Corp Shareholder

Article excerpt

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 [section] 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. …