IRA's Cannot Hold Sub-Chapter 'S' Stock: Trusts Can Though - John R. Dundon II, Enrolled Agent
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IRA’s Cannot Hold Sub-Chapter ‘S’ Stock: Trusts Can Though

IRA’s Cannot Hold Sub-Chapter ‘S’ Stock: Trusts Can Though

To be taxed as an S corporation, a C corporation must elect S status by filing IRS Form 2553. Electing S status is fairly simple for a new or existing corporation, but meeting the requirements for S status can be more complex when the C corporation is not owned by an individual. Eligibility is based on §1361, which states only a “small business corporation” can obtain S status to be taxed as an S corporation. Under Reg. §1.1361-1(e) (1) the person for whom stock is held by a nominee, guardian, custodian or an agent is considered to be the shareholder of the corporation.

In Taproot Administrative Services, Inc. v. Commissioner the IRS disallowed the S election on the basis that an IRA is not an eligible shareholder. They based their opinion on Rev. Rul. 92-73, which disallowed an IRA as a shareholder, stating the code does not specifically address an IRA as a shareholder in an S corporation. Rev. Rul. 92-73 was based on the fact that a beneficiary of an IRA or Roth IRA is not taxed on current income for the year, but taxed when the money is distributed. Trusts allowed to own stocks in an S corporation are taxed currently either at the trust level or the beneficiary level, and are therefore eligible shareholders of an S corporation.

Taxation of IRAs are governed under §408 and §408A, which allow the owners or beneficiaries of an IRA to defer any tax or gain until the amounts are distributed. IRAs are taxed on unrelated business income under §511 where income from an S corporation would be unrelated income for the exempt account.

The Court upheld the IRS’ position regarding Rev. Rul. 92-73, stating IRAs cannot be the owners of S corporation stock because the beneficiaries are not currently taxed on the S corporation’s income, and Congress did not include IRAs in §1361 as eligible S corporation shareholders.