UNITED STATES TAX COUR T
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133 T .C . No . 9
UNITED STATES TAX COUR T
TAPROOT ADMINISTRATIVE SERVICES, INC ., Petitioner _v .
COMMISSIONER-OF INTERNAL REVENUE, Responden t
Docket No . 15396-07 .
. Filed . September 29,,2009 .
R determined that P is ineligible for S
corporation status in 2003 because its shareholder was
a Roth individual retirement account (Roth IRA) . As a
consequence, .R determined that P is taxable as a C
corporation for 2003 .
Held : The Roth IRA is not an eligible S
corporation shareholder . P is taxable as a C
corporation for 2003 .
Steven R . Mather and Kenneth M . Barish ,'for petitioner .
David W . Sorensen , .for respondent .
Served 9/29/09
OPINIO N
WHERRY,
Judge : Thi .s case, which involves a petition for
redetermination of a deficiency for petitioner's 2003 tax year,
is before the Court on respondent's October 23, 2008, motion for
partial summary judgment . See Rule 121(a) .1 Respondent argues
that petitioner is not eligible for S corporation status during
2003 because it had an ineligible shareholder--a Roth individual
retirement account (Roth IRA)--during that year . Petitioner
counters that a Roth IRA is an eligible S corporation shareholder
and that petitioner's S corporation status remained intact . For
the reasons discussed below, we'agree with respondent .
Background
Petitioner is a Nevada corporation that elected S
corporation status and filed its 2003 tax return on a Form 1120S,
U .S . Income Tax Return for an S Corporation .2 Petitioner's sole
shareholder during 2003 was a custodial Roth IRA account for the
benefit of Paul DiMundo . 3
'Rule references are to the Tax Court Rules of Practice and
Procedure . Unless otherwise noted, section references are to the
Internal Revenue Code of 1986, as amended and in effect for the
tax year at issue .
2The Form 1120S indicates that petitioner's S election was
effective Oct . 2, 2002 .
.
3The account was held at the First Trust Co . of Onaga in
Onaga, Kansas .
Respondent issued petitioner a notice of deficiency on April
10, 2007 . Respondent made various determinations, including that
petitioner is taxable as a C,corporation for 2003 becaus .e it had
an ineligible shareholder . Petitioner filed a petition with this
Court on July 6, 2007 . Respondent moved for partial summar y
judgment on the issues of whether petitioner is .el.igible for S
corporation status for Federal tax purposes for 2003 and, if not,
.whether petitioner is treated as a C corporation . for that year .
Petitioner contests that motion .
Discussio n
A.
Summary Judgmen t
Rule 121(a) allows a party to move "for a summary
adjudication in the moving party's favor upon all or any part of
the legal issues in controversy ." Summary judgment is
appropriate "if the pleadings, answers to interrogatories,
depositions, admissions, and any other acceptable materials,
together with the affidavits, : . if any, show that there is no
genuine issue as to any material fact and that a decision may be
rendered as a matter of law ." Rule 121(b) . Facts are viewed in
the light most .favorable to the nonmoving party .
Dahlstrom v .
Commissioner , 85 T .C . 812, 821 ( :1985) . The moving party bears
the burden of demonstrating that no . genuine issue of material
fact exists and that the moving party is entitled to judgment as
a matter of law .
Sundstrand Corp . v . Commissioner , 98 T .C . 518,
4 520 (1992), affd . 17 F .3d 965 (7th Cir . 1994) . The Court has
considered the pleadings and other materials of record and
concludes that there is no genuine justiciable issue of material
fact . Whether a Roth IRA is an eligible .S corporation
shareholder is a legal question appropriate for decision by
summary judgment .
B.
S Corporations : Shareholder Eligibilit y
An S corporation is not generally subject to Federal income .
taxes . Sec . 1363(a) .4 Like a partnership, it is a conduit
through which income flows to . its shareholders . See Gitlitz v .
Commissioner , 531 U .S . 206, 209 (2001) ("Subchapter S allows
shareholders of qualified corporations to elect a `pass-through'
taxation system under which income is subjected to only one level
of taxation .") .
A qualifying "small business corporation" must affirmatively
elect S corporation status, in order to be treated as an S
corporation for Federal income tax purposes . Secs . 1361(a),
1362(a)(1) . That S election terminates automatically and
immediately if,any of the eligibility rules is violated . Sec .
1362(d)(2 ) . For example, if an ineligible shareholder acquires
stock in an S corporation, the S corporation's S electio n
4Although S corporations generally do not pay Federal income
tax, in some circumstances they may be subject to corporate-level
taxes on certain built- in gains and excess passive investmen t
income .
See secs . 1374( a), 1375(a) .
5 terminates on the date on which-the ineligible shareholde r
acquired the stock . Sec . 1362(d)(2)(B) ; sec . 1 .1362-2(b) .(2),
Income Tax Regs . If we agree with respondent that a Roth IRA is
an ineligible S corporation shareholder, then petitioner was not
an S corporation during 20.03 and-should be taxed as a C
corporation for that year .
The S corporation eligibility rules, .which focus on both th e
corporate and shareholder levels, are quite elaborate . Among
those rules are detailed shareholder eligibility requirements
that restrict the number and type of eligible S corporation
shareholders . 'In general, S corporation shareholder eligibility
is limited to domestic individuals, estates, certain trusts, and
certain exempt organizations : See-.sec . 1361(b)(1)(B), (c)(2),
(6) . Section 1361(c)(2)(A) prescribed, as of the tax year at
issue, the types of trusts that are eligible S corporation
shareholders :
(2) Certain trusts permitted as shareholders .-( A) In general .--For purposes of subsection
(b)(1)(B), the following trusts may be shareholders :
(i) A trust all of which is treated (under
subpart E of part I of subchapter J of this
chapter) as owned by an individual who is a
citizen or resident of the United States .
(ii) A trust which was described in clause
(i) immediately before the death of'the deemed
owner and which continues in existence'after such
death, but only for the 2-year period beginning on
the day of the deemed owner's death .
(iii) A trust with respect to stock .
transferred to it pursuant to the . terms of a will,
but only for the 2-year period beginning on the
day on which such stock is`transferred to it .
(iv) A trust created primarily to exercise
the voting power of stock transferred to it .
( v) An electing small business trust .
The list of eligible S corporation shareholders has been
anything but static .
When subchapter S was first added to the
Internal Revenue Code in 1958 ,
the only permissible S corporation
shareholders were domestic individuals and estates .
Reform Act of 1976 ,
1609 ,
Pub .
L .
94-455 ,
In the Tax
sec . 902(c)(2)(A), 90 Stat .
Congress amended subchapter S to allow certain trusts to
own S corporation stock .
Act of 1996 ,
Pub . . L .
In the Small Business Job Protection
104-188 ,
sec . 1316 ( a), 110 Stat . 1785,
Congress amended section 1361 ( b)(1)(B) and added section
1361 ( c)(6) to permit certain tax - exempt . organizations to own S
corporation stock s Although it took effect after the tax year
at issue ,
a more recent and more relevant congressional amendment
permits a bank to make an S corporation election where the bank' s
5The list of permissible tax-exempt .organizations that sec .
1361(c)(6) permits to own S corporation stock includes qualified
pension, profit-sharing,, and stock bonus plans (within th e
meaning of sec . 401(a)) and exempt organizations (within the
meaning of sec . 501(a) and (c)(3)) . Petitioner's Roth IRA was
not a qualified pension, profit-sharing, or stock bonus plan
under sec . 401(a) nor an exempt organization within the meaning
of sec . 50 .1 .
Petitioner does not argue to the contrary .
stock is held in a trust that qualifies as an IRA or a .Roth IRA .
See sec . 1361(c)(2) (A) (vi) . 6
C .
IRAs 7
Provisions for traditional IRAs were enacted into the
Internal Revenue Code as part of the Employee Retirement Income
Security Act of 1974, Pub . L . 93-406, sec . 2002(b), 88 Stat . 959 .,
The IRA provisions were designed "to create a system whereby
employees not covered by qualified retirement plans would have
the opportunity to set aside at least some retirement savings on
a tax-sheltered basis ."
Campbell v . Commissioner , 108 T .C . 54,
.63 (1997) . The basic tax characteristics of a traditional IRA
are (1) deductible contributions, (2) the accrual of tax-free
earnings (except with respect to section 511 unrelated busines s
6The American Jobs Creation Act of 2004 :, Pub . L . 108-357,
sec . 233(a), 118 Stat . 1434, added that provision to sec . .
1361(c)(2)(A) . The added clause applies only to bank stock held
in an IRA or a Roth IRA as of Oct . 22, 2004 . Because of the
temporal limitation a bank cannot qualify for an S corporation
election where (i) any portion of its stock is held in a trust
that qualifies as an individual retirement account and (ii) such
stock was transferred to the trust after Oct . 22, 2004 . We will
discuss that clause and what, precipitated'its addition to the
Internal Revenue Code later in this Opinion . ,
7Although the Internal Revenue Code refers only to IRAs and
Roth IRAs, to distinguish between Roth IRAs and non-Roth IRAs in
this opinion we refer to,non-Roth IRAs as traditional IRAs .
The parties seemingly agree that, for purposes of
eligibility as an S corporation shareholder, there is no
difference, between a traditional IRA and a Roth IRA .
income), and (3) the inclusion of distributions in gross income .'
See secs . 219(a), 408(a), (d) (1) , (e) .
Roth .IRAs are of more recent vintage, having been created as
part of the Taxpayer Relief Act of 1997, Pub . L . 105-34, sec .
302,' 111 Stat . 825, to further encourage individual savings . The
basic tax characteristics of a Roth IRA are (1) nondeductible
contributions, (2) the accrual of tax-free earnings, and (3) the
exclusion of qualified distributions from gross income . See sec .
4 .08A(a), (c) (1), (d) (1) and (2) (A) . 9
Section 408(a) provides in pertinent part that "the term
`individual retirement account' means a trust created . or
organized in the United States for the exclusive benefit of an
individual or his beneficiaries" . However, IRAs and Roth IRAs
can assume another legal form . They can be custodial accounts .
'IRA distributions rolled over pursuant to sec . 408(d)(3)
within 60 days of receipt are excluded from the IRA beneficiary's
gross income . In addition, for-taxable years after 2005 certain .
qualified charitable distributions of up to $100,000 a year made
by an IRA trustee at the IRA beneficiary's direction may be
excludable from the IRA beneficiary's income . See sec .
408(d) (8) (A) .
9The timing of the tax benefit is the critical difference
between traditional and Roth IRAs . A traditional IRA provides an
immediate tax benefit, as contributions are deductible . When
distributions are eventually taken from a traditional IRA, they
will be included in gross income and subject to Federal income
tax . In contrast, there is no immediate tax benefit to Roth IRA
contributions, as they are not deductible . The tax benefit comes
later, when qualified distributions are taken from the Roth IR A
,'and are not included in gross income and are therefore not
subject to Federal income tax .
In that case, they'must be treated asptrusts in order to qualify
as -IRAs See sec . 408(h) . In other words, acustodial account
.IRA must be treated as a . trust in order for-it to' qualify as a n
IRA under-section 408 .
D .
Parties' Argument s
Petitioner has two arguments . - .First, petitioner- argues that
"a custodial account .qualifying as .-an .IRA also meets the
qualifications to be a shareholder . of an S corporation .
According to petitioner, the` beneficiary of-the custodial
account--in this case, Mr . :DiMundo--should be .,considered theshareholder for purposes of--section 1361 . In"'support of that
argument, petitioner-cites'section'1 .1361--1(e,)(1), Income .Tax
Regs .", which provides that "The persona-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'for
purposes of t-his ,paragraph (e) and paragraphs -(f) and (g) of this
section ." Petitioner -also 'cites Rev . Rul ; -66-266, 1966-2 . C .B .
356,
and P.riv . Ltr-. Rul °'(PLR) 86-05-0,28;:"(Nov . : 4, 1985)10 for the
proposition that S ` corporation 'stock°held in -a -custodi"al account
for a disabled person or by a'custodian under the-Uniform Gift s
'°Private letter rulings may not be used or cited as
precedent under sec . 6110(k)(3),'but we . assume that petitioner
cites the 1985 private letter ruling as evidence of the practice
of the Commissioner- . See Hanover'Bank v . Commissioner , 369 U .S .
672, 686 (1962) ; Maadalin v . Commissioner ,' -T .C . Memo . 2008-293
n .7 .
- .10 Minors Act is treated as held by the disabled person or child .
Petitioner's other argument is that an IRA is a grantor trust
that qualifies as an S corporation shareholder under section
1361(c)(2)(A)(i), which provides that eligible S corporation
shareholders include "A trust all of which is treated (under
subpart E of part I of subchapter J of this chapter) as owned b y
an individual who is a citizen or resident of the United
States
. "1 1
Respondent argues that "an IRA custodial account is ver y
different",.from the custodial accounts .that were the subjects of
the revenue ruling and the PLR because in those instances "the
assets are held in a custodial account for someone who can not
legally hold them for themselves, and the income is taxed
currently ."
.Respondent points to the sharp contrast between
those situations and the instant one "where•a person who can
legally hold the asset chooses to transfer such assets to the
custodian so tax benefits can be achieved ." _ Addressing
petitioner's other argument, . respondent points to Rev . Rul . 9273, 1992-2 C .B .. 22 .4, in which the Commissioner concluded that a
trust that qualifies as an IRA-is not a permitted shareholder of
an S corporation .
"Subpt . E of pt .•I of subch . J includes secs . 671-679 .
Trusts that fall under those sections are often referred to as
"grantor trusts" .
- 11
E .
Roth IRAs Are Not Eligible S Corporation ShareholderS 12
.We begin by acknowledging that no statute or regulation in
effect during 2003 explicitly prohibited a traditional or a Roth
IRA from owning S corporation stock . 13 .
At that time, the onl y
legal authority specifically-addressing` the-issue was Rev . Rul .
92-73, supra .'4 Thus, the legal issue presented in this case i s
one of first impression in our Court .
1 .
Deference to Revenue Ruling s
"A `Revenue Ruling' is an official interpretation by the
Service that has been published in the Internal Revenue Bulletin .
Revenue Rulings are issued only by the National Office . and are
published for the information and guidance of taxpayers, Internal
Revenue Service officials, and others concerned ." Sec .
601 .601(d)(2) .(i)(a), Statement of Procedural Rules .
12That is, except for . the limited-transitory relief
explicitly authorized by Congress vis-a-vis S corporation banks .
See su rap . 6 .
13Recently finalized sec . 1.1361-1(h)(1)(vii), Income Tax
Regs ., contains such an explicit prohibition . . The regulation was
effective Aug . 14, 2008 . T .D . .9422,_2009-2 C . B . 898 .
"There is one judicial opinion, involving a case in which
neither the Commissioner nor the United States was a party that
touched on, but did not decide, the issue . See Schuylkil l
Skyport Inn, Inc . v . Rich , Civil No . 95-3128 (E .D . Pa ., . Jan . 6,
1998,) ("All of the parties'-to this litigation recognize that, if
an IRA is a shareholder of a corporation, that corporation under
the Internal Revenue Code and Regulations cannot be a valid
Subchapter `S' corporation .") .
12 We are not bound by revenue rulings, 15 and . .applying the
standard enunciated by the Supreme Court in Skidmore v . Swift &
Co . , 323 U .S . 134, 140 (1944), the weight (if any) that we affor d
them depends upon their persuasiveness and the consistency of the
Commissioner's position over time . See
PSB Holdings, Inc . v .
Commissioner , 129 T .C . 131, 142 (2007) ("[W]e evaluate-the
revenue ruling under the less deferential standard enunciated in
Skidmore v . Swift & Co . , 323 U .S ;. .134 (1944)") .16 Th e
15See, e .g ., Estate of Lang v . Commissioner , 64 T .C . 404,
406-407 (1975) ("A revenue ruling,-,without more, of course, is
simply the contention of one of the parties to the litigation,
and is entitled to no greater weight ."), affd . in part and revd .
in part on other grounds 613 F .2d 770 (9th Cir . 1980) . In
affirming that opinion in part, the Court of Appeals concluded
that "The Tax Court properly declined to defer . to an unreasonable
ruling ."
Estate of Lang v . Commissioner , 613 F .2d at 776 .
16In United States v . Mead Corp . , 533 U .S . 218 (2001), the
Supreme Court recognized that there are various types of agency
pronouncements that may be entitled to differing levels of
deference and that the lowest level of deference-- Skidmore
deference--has continuing vitality . See id . at 234 (" Chevron did
nothing to eliminate Skidmore's holding that an agency's
interpretation may merit some deference whatever . its form, given
the `specialized experience and broader investigations and
information' available to the agency" (quoting Skidmore v . Swift
& Co . , 323 U .S . 134, 139 (1944)) ; id . at 235 (concluding that a
tariff classification ruling by the U .S . Customs Service "may
surely claim the merit of its writer's thoroughness, logic, and
expertness, its fit with prior interpretations, and any other
sources of weight") . In so doing, the Supreme Court set forth a
two-prong test for determining whether to afford an agency
pronouncement Chevron deference .
Id . a't 226-227 ("We hold that
administrative implementation of a particular statutory provision
qualifies for Chevron deference when it appears that Congress
delegated authority to the agency generally to make rules
carrying the force of law, and that the agency interpretation
claiming deference was promulgated in the exercise of that
authority .") ; 'see also Marmolejo-Campos v . Holder , 558 F .3d 903 .,.
(continued . . .)
13 Statement of Procedural Rules acknowledges-the meaningful
distinction to'be drawn between regulations and revenue rulings .
16(
. .continued )
908 (9th Cir . 2009) (en bane) ("Not every agency interpretation
of its governing statute is entitled to Chevron deference,
however .") . .
The Department of the Treasury and the Internal Revenue
Service issue various types of pronouncements including, for
example, Treasury decisions (i .e . regulations), revenue rulings,
revenue procedures, technical advice memorandums, and private
letter rulings . Those pronouncements warrant varying levels of
judicial deference, in accordance with the test set forth by the
Supreme Court in United States v . Mead Corp ., supra . Revenue
rulings do not warrant Chevron 'deference under the test set forth
in United States . v . Mead Corp . , supra -, because they clearly fail
the test's second prong . See Nelson v . Commissioner`, 568 F .3d
662, 665 (8th Cir . 2009) (analyzing a revenue ruling using
Skidmore deference), affg . 130 T .C . 70 (2008) ; Kornman &
Associates, Inc . v . United States , 527 F .3d 443, 454 (5th Cir .
2008) ("Even assuming that revenue rulings satisfy the first
prong of the Mead test, see l .R .C . § 7805(a), they clearly fail
the second .") ; id . ("Furthermore, other circuit courts have
uniformly held that revenue rulings are not entitled to Chevron
deference .") (string citation omitted) ; see also
Aeroquip-Vickers, Inc . v . Commissioner , 347 F .3d 173, 181 (6th
Cir . 2003) ("When promulgating revenue rulings, the IRS does not
invoke its authority to make rules,with the force of law .
Specifically, the IRS does not claim for revenue rulings `the
force and effect of Treasury Department regulations .'" (citing
Rev . Proc . 89-14, 1989-1 C .B . 814))- .
Absent stipulation to . the contrary, the appropriate venue
for an appeal of .the decision in this case is the Court of
Appeals for the Ninth Circuit, in which there is strong support
for affording revenue rulings Skidmore deference . See Texaco
Inc . v . United States , 528 F .3d 703, 711 (9th Cir . 2008) ("We
have held that generally revenue . . rulings are entitled at least to
` Skidmore deference .") ; Omohundro v . United States , 300 F .3d
1065, 1067-1069 (9th Cir . 2002) (per curiam) (analyzing a . revenue
ruling using Skidmore deference) ; McDaniel v . Chevron Corp . , 203
F .3d 1099, 1112 (9th Cir . 2000) ("Though revenue rulings do not
have the force of law, they do constitute a body of experience
and informed judgment to which we may look for guidance .") .
14 See sec . 601 .601(d)(2)(v)(d) ., Statement of Procedural Rules
("Revenue Rulings published . in the .Bulletin do not have the force
and effect of Treasury Department Regulations (including Treasury
decisions), but .are published to provide precedents to be used in
the disposition of other cases, and may be cited and relied upon
,for that purpose .") .
2 . 1.
Persuasiveness
of Rev . Rul . 92-7 3
The rationale underlying Rev . Rul . 92-73,
supra , is
straightforward--traditional IRAs are not eligible ,S corporatio n
shareholders because .the beneficiary
traditional IRA,is no t
taxed currently on th :e IRA's shareof the
S corporation's incom e
whereas the beneficiaries of{the permissible S corporatio n
shareholder, trusts listed in section 1361°(c)"(2)(A) are taxed
currently on the trust's share of such income . 1 7
The revenue ruling's, rationale sensibly distinguishes IRA s
from grantor trusts governed by sections .671-679 . 18
."When a
17Rev . Rul .,92-73, 1992-2 C . B . 224 , was issued before the
Roth IRA provisions were enacted into the Internal Revenue Code .
It referred to IRAs , . which we refer to,as traditional IRAs .
,18 Although Roth IRAs did not exist when the .- revenue ruling
was issued , the Commissioner would have had even more reason to
distinguish Roth IRAs from grantor trusts .
Distributions from a
traditional IRA ..are included - in gross income under sec . 408(d) .
Qualified distributions from a Roth IRA^are not includable in
gross income under sec . 408A ( d) . Thus , if a Roth IRA qualified
as an S corporation shareholder , tax alchemy '` in a free enterprise
business context could be achieved .
This would grant an .
overwhelming competitive tax benefit to a Roth IRA -owned business
compared to a C corporation ._ competitor, who is - subject to two
levels of tax--one-'at the corporate level and another at th e
(continued .. . .)
- 15 grantor,or another person is treated under-subpart E (section 671
and following) as the owner of any portion .of a trust, there are
included in computing his tax liability those items of income,
deduction, and credit against tax attributable-to or-included in
that portion ." Sec . 1 .671-3(a), Income Tax Regs ., ; see Estate of
O'Connor v . . Commissioner , 69 T .C .
165, 174 (1977) ("When a .
grantor or other person . has certain powers in respect of trust
property that are tantamount to-dominion and control over such
property, the Code `lo .oks .through' the trust form and deems such
.grantor or other person to be the owner of the trust property and
attributes the trust income to such person .") . That, of course ,
is not the`case with-traditional and Roth IRAs--earnings accru e
tax free in both entities .19 It follows .that the ta x
18( . . . continued )
shareholder level . Though it can . be argued that the unrelated
business income tax (UBIT),functions to plug this loophole, it is
not clear that the UBIT would do so in a case like the instant
one .
19When Rev . Rul . 92-73, . supra ,,was issued ; Congress had not
yet amended . sec . 1361 to permit certain tax-exempt entities to
own S corporation stock . . See supra p . 6 . With the Small
Business Jobs Protection . Act of 1996,, Pub . .L . 104-188, 110 Stat .
1755, certain tax-exempt entities--including employee stock
ownership plans (ESOPs) that satisfy . the requirements of sec .
401(a)--became eligible S corporation shareholders for the first
time . Petitioner thoughtfully argues that the 1996 amendments
undermine the rationale of Rev . Rul . .92-73, supra , because ESOP
participants are not taxed currently on an S corporation's
income . Petitioner . argues .further that "The analysis used by
respondent in Rev . Rul . 92-73 was implicitly overturned by the
enactment of . the S .-corporation ESOP rules ." We respectfully .
disagree . The 1996 amendments in-no way bear on the
Commissioner's ultimate conclusion in Rev . Rul . . 92-73, supra ,(continued . . .
16 relationship between an individual, beneficiary and a traditional
or ..Roth IRA is not governed by the grantor trust provisions of
subpart E of part I of subchapter J (sections 671-679) .2 0
19( . . .continued)
that the Federal income tax rules relating to grantor trusts are
incompatible with the Federal income tax rules relating to IRAs .
In other words, the fact that Congress has allowed certain taxexempt entities (including ESOPs) to own S corporation stock does
not mean, ipso facto, that IRAs and grantor trusts are treated
the same for Federal income tax purposes . See Staff of Joint
Comm . on Taxation, General Explanation of Tax Legislation Enacted
in the 104th Congress,, at 130-131 (J . Comm . Print 1996) .
Moreover, as explained later in this Opinion, (1) had Congress
intended to allow IRAs to own S corporation stock, it would have
said so explicitly and (2) all available evidence reflects that
Congress has-expressed a contrary intent .
20Whether an IRA assumes the legal form of a custodial
account or a trust is immaterial to whether an IRA is an eligible
S corporation shareholder . Moreover, the fact that Mr . DiMundo's
Roth IRA assumed the form of a custodial account undercuts the
grantor trust argument . Although Mr . DiMundo's Roth IRA is
designated "custodial", it is deemed a trust for purposes of sec .
408 . See sec . 408(h) . Sec . 408(h) provides that custodial
account IRAs are treated as trusts "For purposes of this
section"--meaning for purposes of sec .'408 and no other section .
of the Internal Revenue Code . This means that a custodial
account IRA would not be treated as a trust for purposes of sec .
1361(c)(2)(A)(i) and the grantor trust provisions . Furthermore,
petitioner's reliance on Rev . Rul . 66-266, 1966-2 C .B . 356, and
Priv . Ltr . Rul . 86-05-028(Nov . 4, 1985) for the proposition that
we should look through the custodial account to its owner for S
corporation shareholder eligibility purposes is unpersuasive .
The fact that the Commissioner has applied the law liberally when
dealing with S corporation stock held'for disabled individuals
does not compel us to conclude . that he must extend the,same
liberal application to all S corporation stock held in custodial
accounts whether the owners are disabled or .not .
Finally, petitioner's reliance on sec . 1 .1361-1(e)(1),
Income Tax Regs ., is unpersuasive . Paragraph (e), which is
titled "Number-of shareholders", does not stand for the
proposition that the tax law looks through an IRA trust and
treats its owner/beneficiary-as the shareholder for purposes o f
(continued . . .)
- 17
We also note-that', 'as'a'"technical matter, -traditional and
Roth SRAs•'do not appear to be grantortru :sts,and their taxation
is governed by sections 408 and,408A which . are in subchapter D,
part I, of the-Internal Revenue'Code . Unlike grantor trusts,'
.
traditional' and Roth IRAs 'exist • separate? f=rom their owners for
Federal income tax purposes . Were that not",the case, Congress
would not : have' needed . to subject ~ 'IRAs to : the` unrelated busines s
income tax (UBIT) 2 1
20 ( .
. conti"nued )
determining S corpor-ationshareholder .eligibility ., Unlike the
instances contemplated by the' regulation,--where income
attributable to S . corporation stock (e .g .,,dividends) flows
through a "nominee, guardian, 'cu"stodian, or an agent" to the
individual for whom the stock .is held--such income does : not flow
through an IRA to-its beneficiary . It'is the IRA's income, not
the beneficiary's . An IRA exists on its own--separate from its
beneficiary--and, under sec . '408(e)(1) is exempt from-taxation
unless UBIT is triggered, ,in which . case the-income tax is paid by
the IRA, not its beheTficiary . Althoighthe IRA's accumulated
income will, under current laws eventuallybe released , to, the .
beneficiary or'successor beneficiary in a taxable (tradi'tional
IRA) or nontaxable (Roth_IRA), distribution . stream some time in
the future, that does not make t-he IRA a "nominee, guardian,
custodian,, or,an agent" of_the .ben'eficiary ;,with respect to the S
corporation stock' for purposes of 'sec '1 .1361-1 (e) (1), Income Tax
Regs . See' infra .note 21 . The trust (Mr . DiMundo's Roth IRA) and
not Mr . . DiMundo (the individual)" was ; petitioner's sole
shareholder .
21The UBIT, which is provided for in,secs . .511-514,
functions "to prevent tax-exempt organizations from unfairly
using their tax-exempt'status to compete with commercial
businesses ' Alumni 'Association of-'the Univ . of :Or ., ='Inc . v .
Commissioner , T .C . Memo : 1996-63',°'naffd .' 1193 'F .=3d 1098 - (9th Cir .
1999) . The Internal Revenue .;Code imposes 'UBIT on'-tax-exempt
organizations, including= IRAs See sec . 408(e,)(1) .= , I f -the
Internal Revenue 'Code treated an, IRA's owner as'owning the-IRA's
income--rather than treating the :IRA as'owning'the income
itself--Congress would not have needed to' .,subject',IRAs'to UBIT .
18 In any event, even assuming arguendo that traditional and
Roth IRAs could technically qualify as grantor trusts (because of
their owners' powers and interests), it would be nonsensical to
treat them as such . In the, . case of a grantor trust, the grantor
is subject to tax on the trust's income and gains--the trust is
simply a conduit through which the income and gains pass to the
grantor . See
see also
Estate~of O'Connor v . Commissioner ,
supra at 174 ;
Hornberger v . Commissioner , T .C . Memo . 2000-42 n .5 ("A
grantor trust is not subject to the income tax . Rather, all of
the income and deductions pertaining to a grantor trust must be
taken into account by the grantor ."), affd . 4 Fed . Appx . 174 (4th
Cir . 2001) .22 In stark contrast, the tax law does not look
through IRAs, and no Federal income tax is paid on an IRA's
income and gains (except when UBIT is triggered) . Because the
tax-free accrual of income and .gains'is one of the cornerstones
of traditional and Roth IRAs, it would make no sense to treat
IRAs as grantor trusts thereby ignoring one of their
quintessential tax benefits . As it stands, an IRA--and not it s
grantor or beneficiary--owns the IRA's income and gains, an d
22In fact, a grantor trust that is treated as owned by one
person and meets the requirements of sec . 1 .671-4(b)(2)(i)(A),
Income Tax Regs ., need not obtain a separate tax identification
number, sec . 301 .6109-1(a)(2), Proced . & .Admin . Regs ., and is not
required to file a separate tax return, sec . 1 .6.71-4(b), Income
Tax Regs . Instead, the owner may report the trust's income on
his or her own return .
19
section .,408(e ;) .exempts the IRA from Federalincome'tax (excep t
when UBIT is triggered) .
Finally, since issuing Rev . ,Rul- . 92-73',
supra , the
.Commissioner`has .appliea it consistently togall IRAs . -Fo r
example, the Commissioner regularly invokes Rev . Rill . 92-73,
supra , in,PLRs addressing inadvertent termination :"waiver requests
under section 1362(f) .23 See, -e .'g' ., Priv' .` Ltr . Rul . 2009- .15=020
(Dec . 19, 2008) ; Priv .Ltr . Rul 2008-4`5`=037 .(July 31, 2008)
Priv . Ltr .' Rul 2005-01-013 .(Sept . 29,'2004') .
3.
..
Other Compel-lina'Reasons To Reject the - Leaal .
Interpretation Petitioner- Advocate s
Of more significance thanRev . Rul . 92-73,
supra,
is the
fact that there is no indication that Congress ever intended t o
allow Is to own'S corporation°stock ; .the only available .
evidence suggests otherwise . To begin-with, IRAs' are no t
explicitly listed in section 1361 as eligible S .corporation
shareholders . Had Congress intended to render IRAs eligible S
corporation . shareholders, it could have done so explicitly, as i t
has in the limited case of banks desiring to elect S status . Se e
Traynor v . Turnaae , 485 U .S . 535, 547 (1988),("If Congress ha d
intended : instead that primary alcoholism not be deemed `willful
misconduct' for purposes of § 1662(a)( .1),, as it had been deeme d
23I'f an S co'rporation's S election is inadvertently
terminated (for example, because stock is issued to an ineligible
shareholder), the S corporation can seek a PLR deeming the'
termination inadvertent and permitting the S corporation to
retain its S corporation status . See sec . 1362(f) .
20 for purposes of other veterans' benefits statutes, Congress most
certainly would have said so .") ;
Helvering v . Stockholms Enskilda
Bank , 293 U .S . 84, 93 (1934)-("If it had been intended to make an
exemption in respect of such taxes in favor of nonresidents, it
is reasonable to suppose that Congress would have said so in
explicit terms instead of leaving the fate of taxes upon the
large sums thus involved to depend upon the way in which a court
might happen to construe the word 'resident'--a most
unsatisfactory substitute, as the conflicting decisions in this
and the next succeeding case bear witness ." (fn . ref . omitted)) .
Moreover, the events that precipitated Congress' decision to
carve out the very narrow exception that allows IRAs to hold
shares in S corporation banks reflect that, except for that
limited circumstance, Congress has not permitted IRAs to-own S
corporation stock .
In a section of the Gramm-Leach-Bliley Act, Pub . L . 106-102,
sec . 721, 113 Stat . 1470 (1999) ; titled "Expanded Small Bank
Access to S Corporation Treatment", Congress ordered the
Comptroller General of the United States to conduct a study of
possible revisions to the rules governing,S corporations
including "permitting shares of such corporations to be held in
individual retirement accounts" . Such a study would have been
unnecessary if Congress considered IRAs eligible S corporation
shareholders .
21
.The Comptroller General's response came in the form of
a
June 2000 Government Accounting Office (GAO) report to Congress .
The GAO observed that "Although C-corporation banks are permitted
to .have IRA shareholders, if they wish to become S-corporations
they must eliminate the IRA shareholders" and that "Treasury
officials generally opposed-,this proposal because permitting IRAs
to hold shares in S-corporation banks would create untaxed income
for a potentially long period of time ." U .S . . General Accounting
Office, BANKING TAXATION : Implications of .Proposed Revisions
Governing S-Corporations on .Communit :y Banks 6-7 (GAO/GGD-00-159)
(2000) . Later in . .its report the GAO . noted that "Legal and
accounting experts we interviewed .indicated,that eliminating IRA
shareholders increases the cost and length-of the Subchapter S
conversion process for banks and their shareholders" and went on
to explain why that is so .
Id .
app . IV at 47 .
Congress eventually acted . by adding sect-ion
1361(c)(2)(A)(vi) in 2004 . See supra note 6 . That provision i s
a very narrow one . It permits traditional and Roth IRAs to,be
shareholders of S corporation banks, but only to the extent o f
bank stock held by the IRAs as of .October 22 ., 2004 . The
legislative history underlying that statutory' amendment reflects
that Congress was acting to amend the law because of its belie f
that IRAs were ineligible.S corporation shareholders . See H .
Rept . 108-548 (Part 1), at 129 (2004) ("Under present law, an IR A
cannot be a shareholder of an S corporation ."
- 22 If petitioner is correct, then that change in law--preceded
by a congressionally mandated study--was unnecessary, . and in
enacting section 1361(c)(2)(A)-(vi) Congress engaged in a useless
act after sending the Comptroller General on a fool's errand .
Although interpretations by a subsequent Congress of .a previous
Congress' legislative intent are not controlling,24 we are .
reluctant to impute a useless act to Congress and to reach a
conclusion that renders an entire clause of section 1361 mer e
surplusage . See United States v . Hecla Mining Co . , 302 F .2d 204,
211 (9th Cir . 1961) ("We cannot assume that Congress did a
useless act . The fact that Congress'saw fit to enact thi s
amendment confirms our conclusion that there . may be no offset in
the computation of interest .") .
The trend toward- .increased flexibility for S corporations
means that the time may come when Congress sees fit to allow IRAs
to own stock in any S corporation .25 For now, as in 2003, that i s
24Although a subsequent Congress' view of a prior Congress'
action is not controlling, see United States v . Phila . Natl .
Bank , .374 U .S . 321, 348-349 (1963) (observing that "`The views of
a subsequent Congress form a hazardous . basis for inferring the
intent of an earlier one"' (quoting United States v . Price , 361
U .S . 304, 313 (1960))), a subsequent Congress' .view is certainly
entitled to weight in a case like this one, see Seatrain
Shipbuilding Corp . v . Shell Oil Co . , 444 U .S . 572, 596 (1980)
("[W]hile the views of subsequent Congresses cannot override the
unmistakable intent of the enacting one, such views are entitled
to significant weight, and particularly so when the precise
intent of the enacting Congress is obscure" (citations omitted)), .
25On May 7, 2009, a bill was introduced in the Senate that
would expand S corporation shareholder eligibility to include all
(continued . . .)
-: 23 not the case . As a consequence, Mr . DiMundo's Roth IRA was not
eligible to own shares in petitioner . Because it did, petitione r
was ineligible for S corporation status in 2003 .
See sec .
1362(d)(2) . Petitioner is therefore a C corporation for Federal
income tax purposes for the 2003 tax year .
The Court has considered .all of petitioner's contentions,
arguments, requests, and statements ., To the extent not discussed
herein, we conclude that they are meritless, moot, or irrelevant .
To reflect .the foregoing,
An appropriate order will
be issued granting respondent's
motion for partial summary
judgment .
Reviewed by the Court .
COLVIN,•COHEN, WELLS, HALPERN, VASQUEZ, GALE, THORNTON .,,
MARVEL, GOEKE, GUSTAFSON, and PARIS, JJ ., agree with this
majority opinion .-
25 ( .
continue d
traditional and Roth IRAs by modifying sec . 1361 .(c)(2)(A)(vi)
See S . 996, 111th Cong' ., 1st Sess ., sec .-6(a) (2009) . The same
proposal was introduced in .the Senate in each of the two
preceding Congresses . See'S . 3063, 110th Cong ., 2d Sess ., sec .
6(a) (2008) ; S . 3838, . 109th Cong ., 2d Sess ., sec . 102(a) (2006) .
24 -
HALPERN, J ., concurring : I agree with much of the majority .
opinion but write to supplement the argument therein .
In this case, we must decide whether a Roth IRA is a prope r
shareholder of an S corporation . Because the Roth IRA is
a
custodial account, petitioner argues that, pursuant to section
1 .1361-1(e)(1), Income Tax Regs ., its beneficiary, Mr . DiMundo,
is considered the shareholder of the S corporation . Mr . DiMundo,
of course, would be a proper S corporation shareholder .
I agree with Judge Holmes as .to the meaning of section
1 .1361-1(e)(1),, _Income Tax Regs . Yet acceptance of that meaning
is only the starting,point•for an analysis of the interaction
between the, rules governing S corporations and those governing
IRAs . See, e .g .,.
Boys Markets, Inc . v . Retail Clerks Union,
Local 770 , 398 U .S . 235, 250 (1970) ("Statutory interpretation
requires,more than concentration upon isolated words ; rather,
consideration must be given to the total corpus of pertinent law
and the policies that inspired ostensibly inconsistent
provisions .") .
Custodial accounts constituting IRAs are accorded special
(tax-exempt) treatment by section 408(e)(1) . The general rule
for custodial accounts (as the majority notes, see majority op .
note 20) is flowthrough taxation of the beneficiary ; i .e . ,
current inclusion of-income, etc . That tax. treatment . is a key
characteristic of . custodial accounts and, presumably, the`
rationale for considering the beneficiary of a custodial account
that holds S corporation stock to be a shareholder of the S
- 25 corporation . The S corporation thus earns income that (thanks to
the regulation)-is considered to~flow directly to the beneficiary
of the custodial account . Custodial accounts qualifying as IRAs,
however, preclude that flowthrough tax treatment, eithe r
deferring taxation of (what is still pretax) income (traditional
IRA) or exempting that income entirely (Roth IRA) .' For tha t
reason, a custodial account qualifying as an IRA utterly subverts
the rationale for the attribution rule in the regulation . Thus,
I do not consider the regulation as authority that a custodia l
account qualifying as an IRA is a proper shareholder of an S
corporation 2
In short, the critical attributes of an .IRA--i .e ., deferral
of or exemption from taxation--are antithetical to the rationale
for permitting custodial accounts to be shareholders of
S
corporations . Section 408 affords exceptional (and highly
favorable) tax treatment to certain custodial accounts . For tha t
'In his dissent, Judge Holmes quotes sec . 1 .1361-1(e)(1),
Income Tax Regs ., as follows : "Ordinarily, the person who would
have to include in gross income dividends distributed with
respect to the stock of the corporation (if the corporation were
a C corporation) is considered to be the shareholder of the
corporation ." Dissenting op . p . 29 . Yet the effect (indeed, the
purpose) of sec . 408 is to -alter the tax dynamics of that
distribution--the person who owns C corporation stock through an
IRA need not (of course) include in gross income any dividend so
distributed .
2Judge Holmes argues that "the stakes are not that great" .
Dissenting op . p . 57 . But that misses the point . I suggest
that, regardless of the financial stakes, the logic of the
statute precludes the result petitioner seeks .
26 reason, IRAs are different in kind from regular custodial
accounts .and thus are not eligible S corporation shareholders.
GALE, THORNTON, MARVEL, GOEKE,and WHERRY, JJ .,_agree with
this concurring opinion .
27 -
HOLMES, J .., dissenting : In 2003, there were 2500 shares of
stock in Taproot Administrative Services, Inc ., titled "First
Trust Company of Onega, as custodian for Paul DiMundo ." A regulation states that "[t]he person for whom .stock .of a corporatio n
is held by a * * * custodian * * * is considered to be the share
'holder of the corporation . The First Trust . Company of Onega i s
a custodian . DiMundo would therefore seem to be the person wh o
is considered to be Taproot's shareholder .2 Since he is undoubtedly an individual, why exactly is it that Taproot . is disqualified from being an S corporation? If enough commentators say
"IRAs can't be S-corporation shareholders" or, more precisely,
"the IRS says IRAs can't be S corporation shareholders," does
that make it so? 3
And might we not be subtly assuming the .conclusion by phrasing the questions that way, when it might turn out to be the case
that IRAs--at least some IRAs--don't own property themselves, but
are instead a form of ownership ?
1
2 The Commissioner subtly restates the ownership by
paraphrase, variously stating in his . motion that DiMundo's"Roth
IRA was the shareholder, Mot . at 2 ; that the stock was held in a
custodial IRA account for the bonefit-of~ :DiMundo's self-directed
Roth IRA, Mot . at 3 ; and that the stock was owned by the trust
company as custodian for DiMundo, .Sorenson Decl . at 2' . We should
of . course not sort this out on a .summary-judgment motion, but
instead assume the supportable'facts most in Taproot's favor .
3
Taproot and its companion cases are only a few of nearly
a hundred pending before the Court . Fourteen were assigned to my
division, but the parties settled them'and decided to mak e
Taproot the test case .
28 I .
The majority's analysis of this question--apart from a brief
mention in a footnote, see majority op . note 20--drifts away from
.construing the regulation into an exegesis of a revenue ruling
dealing with IRAs set up as trusts,4 private letter rulings, 5 and
legislative nonhistory6 (i .e ., the story of what some Congresse s
thought previous Congresses had decided, or even what some agencies told Congress the IRS thought that previous
Congresses ha d
decided .)
I begin with the Code . Section 1361(b)(1)(B) defines an S
corporation (which the Code more formally calls a "small business
corporation") as a domestic corporation "which does no t
have as a shareholder a person (other than an estate, a trust
described in subsection (c)(2), or an organization described in
subsection (c)(6)) who is not an individual ." An S corporation's
shareholders must be somewhere on this list . Taproot argues that
DiMundo qualifies because he is an individual person .
That should be obvious . When the Code doesn't define a
term, courts try to construe it in accordance with its ordinary
everyday meaning .
United States v . New Mexico , 536 F .2d 1324,
1328 (10th Cir .,1976) . And the term "individual" means a human
being . . Jonson v . Commissioner , 353 F .3d 1181 (10th Cir . 2003),
affg . 118 T .C . .106 (2002) ; see also Liddane v . Commissioner , T .C .
See majority op . p . 11 .
See majority op . pp . 18-19 .
See majority°op . p . 19 .
- 29
Memo . 1998-259,af.fd . without published opinion'208 F .3d 206 (3d
Cir . 2000) . Section 7701(a)(1)- includes "individual": in its list
of those whom the Code regards as "persons," along with "a'trust,
estate, partnership, association, company or corporation ." But
when property is held by a custodian for the benefit of another,
who counts under section 1361(b)(1,)(B) as an "individual person?"--the'holder, the' beneficiary, or the account .'itself? . The
Secretary should be the one resolving such ambiguity-in the Code .
And he has .
In 1995, the Secretary -filledthis particular-gap with
section 1 .1361 .-1(e), Income Tax-Regs . This regulation tells us
who counts as an individual shareholder'of an .S corporation :
Ordinarily, the person who would have to include in gross
income dividends distributed with respect to the stock of
the corporation .(if the corporation were a C corporation) is,
considered to be the shareholder of the' corporation .
The regulation explains by example how to apply this general
principle in the cases of ownership by a married couple, by
tenants in common, or by joint-tenants . But then it reverts to
stating a general rule for other ambiguous cases :
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 for purposes of this
paragraph (e) and paragraphs (f) and (g) of this section .
* * * {]
.7]
7 While section 1 .1361-1(e), Income Tax Regs ., is
captioned "Number of shareholders," and the majority apparently
dismisses its relevance to the question of_who may own S
corporation stock in part 'on that account, .see majority op . note
20, that argument is belied by the cross-reference to paragraphs
(f)- and (g) . Even if captions count, section 1361-1(f), Income
Tax Regs . ("Shareholder must be an individual or estate"), doe s
(continued . . )
- 30 The Code doesn' .t define "custodian", . but the . dictionary
definition is "one, entrusted officially,with guarding and keeping ." . Merriam Webster'sThird-New International Dictionary 559 .
(2002) . That fits here, and is similar to other uses . of the word
.in federal law . . See, e .g ., 31 U .S .C . sec . 3302(a),(2006) .(custodian as someone who- .keeps money safe without using it<himself) ;
Marshall .v . Marshall,
547 U .S . 293, 310 n . .4 (2006) (alien proper-
ty custodian as . someone who receives, holds, administers, and accounts . for money) . This seems to fit with what .the Onega .trust
company was doing for DiMundo . I . conclude from this that Onega
actually is'a custodian of the .S-corporation stock .
That Taproot's . stock is held by a .custodian i .s .not enough,
of course, for it .to qualify as an S corporation . Let .uspgo to
the regulation again . It 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 for purposes of this
paragraph (e) and paragraphs ( f) and . ( g) of this section .
For example , a partnership may be a'nominee of S corporation
stock for a person who qualifies as a shareholder of an S
corporation .
However , if the partnership is the beneficial
owner of the stock , then the partnership is the shareholder,
and the corporation does not qualify as a small business
corporation .
Sec . 1 .1361-1(e)(1),,Income Tax Regs . (Emphasis added .)
Who,'then, is the "person for whom stock of a corporation i s
held?" The italicized phrase from the last sentence-in the-excerpt leads me to read the regulation as equating "beneficial
.
7( . . .continued)
.tell us who qualifies as ashareholder, and expressly includes in
the list anyone who counts as a shareholder under section 1 .13611(e-), Income Tax Regs
- 31 owner" with "the person .for whom .stock of a : .corporation is held ."
And this would'mean,'=in a case like this one, .that the correct
question is : "Who's the beneficial owner of the Taproot stock
held in the IRA? "
Whether DiMundo's IRA custodial account makes him the beneficial .owner depends upon the terms-of his contract with the custodian and". .applicable-local law .- We recently held, for example ,
11
that although a partner had title'to a partnership interest he
was not its beneficial owner because the income" .from the partnership was distributed to his mother .
Windheim v . Commissioner ,
T .C . Memo . 2009-136 . And the Commissioner himself has already
ruled that "for purposes of determining-who is a shareholder
under the-provisions of Subchapter S of,the'Code, beneficial
ownership of the stock rathertharf technical legal . title is co n
-trolling ." Rev- : . Rul . 70-615, 1970-2 C .B . . 169, clarified by Rev .
Rul . 75-261, 1975-2 . C .B . 350 ("accordingly, since under the facts
in Revenue Ruling 70-615, the taxpayer held the share of stock as
an accommodation for the'transferor under an `acknowledgment of
trust' and had no beneficial interest therein the taxpayer i s
.properly characterized as a nominee, and not as a trustee") .
The problems with figuring out-who, exactly, counted when a
stock's title was held by"a nominee or .agent'caused much litigation before the 1995 regulation .- See, e .g .,
Wilson v . Commis-
sioner , 560 F .2d 687, 689(5th Cir ."1977) (beneficial ownership
of stock', not mere record ownership,or other formal indicia, determines who bears those tax consequences), affg . T .C . Memo .
32 1975-92 ;
W & W Fertilizer Corp . v . United States , 527 F .2d 621,
626 (Ct . Cl . 1975) (trusts, but not custodians, count as real
parties in interest for consenting to subchapter S status) ; 'Kean
v . Commissioner , 469 F .2d 1183, 1187 (9th Cir . 1972) ("`shareholders' who must file-a consent are not necessarily 'shareholders of record' but rather beneficial owners of shares"), affg .
in part and revg . in part 51 T .C . 337 (1968 .) ;
Commissioner , 73 T .C . .370,
controls) ;
Danenbera v .
3 90 (1979) (beneficial ownership
CHM Co . v . Commissioner , 68 T .C . 31, 37 n .13 (1977 ;
Hoffman v . Commissioner , 47 T .C . 218, 233-234 (1966) (beneficial
ownership, not technical legal title, critical factor), affd . per'
curiam 391 F .2d 930 (5th Cir . 1968) .
But let's assume on this motion for summary judgment that
DiMundo (and not someone he's designated) would be that beneficiary . As applied to this case, then, section 1 .1361-1(e)(1), Income Tax Regs ., would read : "For purposes of paragraph (e) (limit
on number of . shareholders) and paragraph (f) (shareholders must
be individuals), the person for whom stock of the corporation is
held (Paul . DiMundo) by a nominee, guardian, custodian, or an agent (Onega) is considered to be the shareholder of an S corporation (Taproot) ." This reading seems to make sense .
Taproot cited . Revenue Ruling 66-266, . 1966-2 C .B . 356, and
Priv . Ltr . Rul . 86-05-028 (Nov . 4, 1985) to support its reading
of the regulation . The Commissioner seized on these pre-1995
citations and urged that they be read as limited to custodians
33
for property held by minors and disabled persons . The majorit y
agreed :
The fact that the Commissioner' has applied the law liberally
when dealing with S corporation stock held for disabled
individuals does not compel us to conclude that he must
extend the same liberal application to all S corporation
stock held in custodial accounts whether the owners are
disabled or not .
See majority op . note 20 .
The reasoning of Revenue Ruling 66-266 needs to be qualified .
in light of 40 years' of amendments to the S corporation rules,
amendments that have now created a legal environment where the
initial rule--only individuals and estates of decedents can hol d
S corporation stock in their own names --has been superseded by a n
expanding list of exceptions, stretching
from tax-exempt organi-
zations (under sections 401k and 501) to ESOPS, QSSTs, trusts ,
corporations, and partnerships .
The 1966 revenue ruling was important at the time for starting to erode the law's focus on title . But the regulation's
establishment as a general principle that title won't matter if
stock is held by one entity for another was an avulsive change .
What matters now is whether the beneficial owner of the stock is
an eligible owner .
The list in section 1 .1361-1(e)--"nominee, guardian, custodian, or an agent"--has no limitation based on the disability of
any individual beneficiary . And the use of the word "custodian"
- 34 strongly suggests that a plain reading of the regulation support s
the taxpayer's position here . '
Bankruptcy courts, which have some expertise in the area,
have no trouble•holding that the beneficial interest of a debtor
in an IRA held by a custodian (or a trustee, for that matter) is
attached by the section 6321 federal tax lien, classifying IRAs
as the debtor's own property under 11 U .S .C . sec . 541 (2006) .
See, e .g .,
Schreiber v . United States , 163 Bankr . 327, 334
(Bankr . N .D . Ill . 1994) ;
Crystal Bar, Inc . 'v . Cosmic, Inc . , 758
F . Supp . 543, 544, 551 (D .S .D . 1991) ;
227
Deppisch v . United States ,
Bankr . 806, 808-09 (Bankr . S .D . Ohio 1998) . This gives the
IRS the power to seize taxpayers' property held in an IRA . See
secs . 6331-6334 ;
Kane v . Capital Guardian Trust Co . , 145 F .3d
1218, 1223 (10th Cir . 1998) (right to liquidate IRA undoubtedly
constituted a "right to property" subject to levy) ;
Equitable
Life Assurance Socy . of the United States v . Mischo , 363 F . Supp .
2d 1239, 1245-46 (E .D . Cal . 2005) . Such cases suggest that the
beneficial owner of property held in a custodial individual
retirement account is the owner of the IRA .
Nonetheless, the majority dismisses the regulation's
applicability because :
That regulation * * * does not stand for the proposition'
that the tax law looks through an IRA trust and treats its
owner/beneficiary as the shareholder for purposes of
determining S corporation shareholder eligibility . Unlik e
8 It is striking that the Commissioner chose to discuss
the revenue ruling, and even private letter rulings, in his
brief, but omitted any mention of what seems to be a
directly-on-point regulation .
- 35 the instances contemplated by the regulation--where income
attributable to S corporation stock (e .g ., dividends) flows
through a "nominee, guardian, custodian, or an agent" .to the
individual for whom the stock is held--such income does not
flow through an IRA to . its beneficiary . It is the'IRA'sincome, not the beneficiary's . .
See majority op . note 20 . I don't think this is right--a custodial IRA .is an account, not a trust--and while it is certainly a
method of owning something, it's not obvious that a custodia l
account itself is an entity capable of owning anything . One
wouldn't say, for example, that "Blackacre was owned by a tenancy
by the entirety," one would say that "Mr . and Mrs . X owned Blackacre as tenants by the entirety ." And so the final question to
ask of the regulation is whether a custodial account is itself
"the person for whom stock of a corporation is held" by a custodian . The majority's dismissal seems odd in light of the power
of both bankruptcy courts and the collection arm of the IRS to
take property in IRAs to pay their owner's debts in a way they
never would . if the IRA were a legally distinct person .
The majority does make one,,textual argument . It reasons in
note 20 that IRAs must be separate entities because unrelated
business income tax (UBIT) is imposed on them :
An IRA exists on its own--separate from its beneficiary-and, under section 408(e)(1) is exempt from taxation unless
UBIT is triggered, in which case the income tax is paid by,
the IRA, not its beneficiary . Although, the IRA's accumulated income will, under current law, eventually be released
to the beneficiary or successor beneficiary in a taxable
(traditional IRA) or nontaxable (Roth IRA) distribution
stream sometime in the future, that does not make the IRA a
"nominee, guardian, custodian, or an agent" of the beneficiary with respect to the S-corporation stock for purposes of
section 1 .1361=1(e)(1), Income Tax Regs .
- 36 But the language of section 408(e) .subjecting IRAs to UBIT9
seems not that much different from the language of the Code' s
excise taxes . 'Section 4041(a)(1)(A), for example imposes "a tax
on any liquid other than gasoline ." But no one would say that a
gallon of diesel fuel is a person . Instead, regulations define
what "person" is liable for the tax . See, e .g ., sec . 48 .4041- .
4(b), Manufacturers & Retailers Excise Tax Regs . And, like
section 408(e), section 3121(1)(4), refers to "wages subject to
the taxes imposed by this chapter"--obviously referring not to
"wages" as a "person" owing a tax, but wages earned by a person
owing the tax (and, . in context) wages as the source`of the tax's
payment . The majority is ascribing tax incidence--who bears the
tax liability--to rules about tax reporting and withholding .
The more fundamental problem with this reasoning is that, as
I've already noted,
supra p . 29,
the Code itself defines
"person," and custodial accounts are not on that list . See
Eustice & Kuntz, Federal Income Taxation of S Corporations ,
par . 3 .03[9] n .145 (4th ed . 2001) ("perhaps the account is not an
entity at all, and the individual should count as the direct
shareholder for purposes of IRC § 1361 . See IRC § .408(h) fo r
9 UBIT is a tax imposed by section 511, on the income of
.otherwise tax-exempt entities derived from a trade or busines s
that is regularly engaged in and which is not substantially
related to the reason the entity is tax-exempt--for example, a
pasta company owned by a law school .
C .F . Mueller Co . v .
Commissioner , 190 F .2d 120 (3d Cir . 1951), revg . 14 T .C . 922
(1950) . Sections 408(e)(1) and 408A(a) subject both traditional
and Roth IRAs to UBIT .
37 support . .") 10'
As the Ninth, Circuit-has held, "determining who is a
beneficial shareholder requires analysis of the actual role the
shareholder has played in corporate governance . • Pahl v .
Commissioner , 150 F .3d 1124, 1129 '(9th Cir .1998), affg . T .C .
Memo . 1996-176 . In various custodial account agreements
preapproved by the IRS, the depositor (owner) is responsible for
providing information to the custodian ;" he can combine IRAs t o
satisfy the minimum distribution' requirements under section
408 (a) (6) ;12 he' can replace the custodian at any time ; 13 he i s
10
In a private letter ruling not cited by the
Commissioner or the majority, the-IRS decided long ago that the
,owner of S corporation shares in a custodial account is_not the
custodian or the account but the owner of the account . Priv .
We don 't'rely on this
Ltr . Rul . 80-10-028 (Dec . 11, 1979) .
ruling, since the Code forbids us from relying on private letter
rulings as precedent, even those cited by both parties (and
See sec . 6110(k)(3) .
discussed briefly by the majority) .,
11
"The Depositor agrees . to provide the Custodian with al l
information necessary to prepare any reports required by section
Southwest
408(i ) and Regulation sections 1 .408- 5 and 1 . 408-6 ."
Inc
.,
Individual
Retirement
Custodial
Account
AgreeSecurities ,
ment and Disclosure Statement ( 2002 ) .( SWS), par . 5 .01, ,
htt p ://www .wi s consindisco u nt .com/lpdfs /`IRAAareementO5 06 .pdf .
see-also Fidelity Investments, Fidelity IRA and Roth IRA
Custodial Agreements ( 2009 ) ( Fid e' l- i.ty), art . V (IRA ) and'art VI
(Roth ), http : // personal . fidelity . com/accounts /p df/custodials .pdf .
12 "The owner of two . or more traditional .IRAs'may satisfy
.minimum
distribution requirements described above by taking
the
from one traditional IRA the amount required to satisfy the
requirement for another in accordance with the regulations under
section 408(a .)(6) ." SWS, par . 4 .06 ; Fidelity, art . IV, par . 6
(IRA) ; TD AMERITRADE Clearing, Inc' :, Roth IRA Disclosure
Statement & Custodial-Agreement (2007) (Ameritrade)
http•//www'tdameritrade .com/forms/AMTD40l .pdf , art . II .
13 "The Depositor may at any time remove the .Custodian and
replace the Custodian with a successor trustee or custodian of
the Depositor's choice by giving 30 days notice of such remova l
(continued . . .) .
38 himself responsible for any fees, taxes and administrative
expenses ;" and he9 .directs,and controls the investments in the
account .15 Such agreements--while obviously not controlling here=at least suggest in their apparent uniformity that custodialaccount IRAs would likely be found at trial to be under the
control, .of their owners . It is hard to see how they could be
considered "persons",of their own, instead .of channels through
which . their . owners direct and manage their investments .
And a longer look at the regulation shows that it doesn't
make immediate taxability a defining characteristic of custodial
accounts .16 Instead, it makes the key characteristic th e
13(
. .continued)
and replacement ." SWS, par . 8 .04(b) ; Ameritrade, art . X .
14 "All such fees, taxes, and other administrative expenses
charged to the account shall be collected either from the assets
in the account or from any contributions to or distributions from
such account if not-paid by the Depositor ., but the Deposito r
shall be responsible for any deficiency ." SWS, par . 8 .05(c) ;
Fidelity, art . IX, pars . 16, 18 (Roth) ; Ameritrade, 8 .01(c) .
15 "At the direction of the Depositor * * * the Custodian
shall invest all contributions to the account and earnings
thereon in investments acceptable to the Custodian * * * . . The
Custodian shall have no duty other than to follow the written
investment directions of the Depositor, and shall be"under no
duty to question said instructions and shall not be liable for
any investrdent losses sustained by the Depositor ." . SWS, par .
9 .01 ; Fidelity, art . IX, par . 2 (Roth) ; Ameritrade, art . VI .
16 Another textual argument, though unmade by the
Commissioner, is to play with the distinction in section 408(h)
itself, which treats custodial IRAs as trusts "for purposes of
this section" but their custodians as trustees "for purposes of
this title ." (Emphases added .) The Commissioner might hav e
argued that, because section 1361 is part of "this title," then
"custodian" in the regulation should be read to mean "trustee ."
Treating the custodian as a trustee (with its imposition b y
reference of recordkeeping,duties like those found in section
(continued . . .)
39 beneficial` enjoyment of the account .A Arid the'regulation itself
lists other entities or exempt organizations as eligible owners
of S corporation stock .' '
Indeed, the relationship between the custodian and the S
corporation's stock was described'by the leading treatise as the
custodian's holding "nominal' ownership" versus the owner of the
account's "beneficial' ownership ." See Eustice & Kuntz, Federal
Income Taxation of S Corporations, par . 3 .03[18], at 3-90 (Supp .
2 2009) . And the Commissioner has adopted that distinction when
it suits him . IRS Coordinated Issue Paper on S Corporation Tax
Shelters, at 6 (Nov . 8, 2004) ("Because the exempt party appears
to be'simpl'y a facilitator without beneficial ownership of the
16(
S
. .continued )
6047) does not, however, mean-that the custodial account would
become a trust .
The Secretary does-know how to-write regulations that would
make that happen . For example, section 401(f) (governing
qualified pension and benefit plans) says that "For purposes of
this title, in the case of a custodial account * * * the person
holding the assets of such account * * * shall be treated as the
trustee thereof ." But the regulation--section 1 .401(f)1(c)(1)(i), Income Tax Regs .--specifies . that "Such a custodial
.account * * * is treated as a separate legal person which is
exempt from income tax under section 501(a) . In addition, the
person holding the assets of-such account`* * * is treated as the
trustee thereof ." (Emphases added . )
17 The Secretary put this language into section
1 .1361-1(e), Income Tax Regs . 1995 . See T .D . 8600, 1995-2 C .B .
135 . He revisited the language in 2002-(each potential current
beneficiary of the ESBT is counted as a -shareholder of any S
corporation whose stock is owned by the ESBT, T .D . 8994, 2002-1
C .B . 1078 ; and less. than a year ago (providing that the
beneficiary of an ESBT orrthe beneficiary . of an IRA are
considered the S corporation shareholders, T .D . 9422, 2008-2 C .B .
8 .98 .
- 40 corporation stock, the exempt party generally should not be
treated as a shareholder for purposes of the allocation o f
income .")18
So we have a regulation whose validity is unchallenged b y
either the majority or the Commissioner .l9 Nor does it seem
possible that such a_challenge could have succeeded under
Chevron
step one, which tells us to ask whether Congress "has directly
spoken to the precise question at issue ."
Chevron, U .S .A . Inc .
v . Natural Res . Def . Council, Inc . , 467 U .S . 837, 842 (1984) .
The majority concedes as much . See majority op . note 20 .
Chevron . step two--whether the agency's solution is reasonable-seems equally easy to climb : A focus on the beneficial ownership
of stock under a custodian's control looks directly at who
ultimately bears the benefits and risks of S corporation stoc k
ownership20 and gives us a reasonable answer to the question o f
18 Coordinated issue papers, like revenue rulings, are
drafted by IRS attorneys and represent "`merely the opinion of a
lawyer in the agency and must be accepted as such', and are "not
binding on the * * * courts ."' See N . Ind . Pub . Serv . Co . v .
Commissioner , 105 T .C . 341, 350 (1995) (quoting Stubbs, Overbeck
& Associates, Inc . v . United States , 445 F .2d 1142, 1146-47 (5th
Cir . 1971)) ., affd . 115 F .3d 506 (7th Cir . 1997) .
19 The Ninth Circuit long ago upheld the pre-1995 version
of the regulation, sec . 1 .1371-1(d)(1), Income Tax Regs .
Kean v .
Commissioner , 469 F .2d 1183, 1187 (9th Cir . 1972), affg . in part
and revg . in part 51 T .C . 337-(1968) .
20 See also Wilson v . Commissioner , 560 F .2d 687, 690 (5th
Cir . 1977) . ("Shareholders in close corporations generally have
some role (however formal or minor) in corporate governance, bear
a risk of corporate failure, and stand to share in corporate
successes . The .extent to which the individual in question .
exhibits these characteristics helps determine whether-he,is a
beneficial shareholder ."), affg . T .C . Memo . 1975-92, cited,i n
(continued . . .)
4'1 whether DiMundo can put his Taproot stock in a custodial - account
IRA without triggering Taproot ' s transformation into a C
-corporation .
The dispute within our Court should have been
on the meaning
of the actual words of the regulation,` but . the majority shifts.
its focus to a set of authorities that can 't help- us in ' construing that language .
I tag along .
The majority' s conclusion rests -on old Revenue . Ruling 92-73,
rules relating to grantor trusts ,
congressional inaction in
response to the IRS ' s continuing - reliance on the revenue ruling
in-'the PLRs it issues ,
and numerous statements by organizations
hovering around Congress about the current state - of the'IRS's
views on the' subject . 21 While consistent ,
these. spotty
indications are not controlling law but merely demonstrations
that the authors of the PLRs haven ' t thought through the meaning
of the 1995 regulation against a
background `of
steady expansion
in S-corporation shareowning eligibi l
20( . . .continued)
Christian & Grant, Subchapter S .Taxatio.n, par . 14 :04 (4th ed .
2000) ("Who Must .Consent") .
21 The majority admits-"that no,statute or regulation in
effect during 2003 explicitly prohibited a traditional or a Roth
IRA from owning S corporation stock ." See majority op . p . 11 .
It further argues that section-1 .1361-1(h)(1)(vii), Income Tax
Regs ., effective Aug . 14, 2008, contains such an explicit
prohibition . . As we shall explain, we do not think the 2004
amendment applies to IRAs in nonbank S corporations, and
certainly not custodial IRAs, which .are governed by section
1 .1361-1(e), Income Tax Regs .
4 .2 The three themes flowing through the majority opiniondeference,to the revenue ruling and the Commissioner's continuing
reliance on it, disagreement with any characterization of IRAs-as
,grantor trusts,-and such legislative history as exists, al l
spring from these authorities .
I will look at•each .
A.
The majority packs most of its reasoning aboard Revenue Rul-
ing 92-73, which cursorily held that IRAs couldn't be considered
, grantor trusts, in determining their eligibility as S-corporation
shareholders because the rules that apply to grantor trusts "are
incompatible with-the rules that apply to" IRAs . Yet the revenue
ruling answered a single question : "Is a trust that qualifies as
an individual-retirement account under section 408(a) of th e
Internal Revenue Code a permitted shareholder . of an .S corporation
under section 1361? "
The ruling reviewed'Code section 1361(c)(2)(A)(i) and
1361(d)•(l) .and reasoned :
A section 408(a) trust cannot also be a trust described in
section 1361(c)(2)(A)(i) or a QSST treated as a trust described in section 1361(c)(2)(A)(i) because the rules that
apply to a trust described in section . 1361(c)(2)(A)(i) o r
,ASST treated as such a trust are incompatible with the rules
that apply to a section 408(a) trust . Therefore, a section
408(a) trust cannot satisfy the rules applicable to a trust
that is,a permitted . shareholder of an S corporation .
(Emphases added )
This revenue ruling is much too weak a plank to bear th e
load :the .=majority puts on it . First and foremost, as .emphasized
above,,the ruling-is aimed at IRAs held as
trusts governed by-
43 section 408(a) . The account in our case is not a
trust ;
it's a
custodial account . Custodial account IRAs are'not "true trusts . "
Walsh v . Gahloway , 308Bankr .
.709, 713-14'(Bankr . W .D . Pa . 2001)
(section 408(a) limits the characterization of custodial-account
IRAs as trusts to that section alone) . ; see also infra p .'44 .
The majority's lengthy discussion, see majority op . pp . 1418, of IRAs as grantor trusts is understandable in light of the
Commissioner's own extended, analysis along this line, and `his
refusal to engage in the regulatory analysis that Taproot did . .
(And to .be fair, Taproot itself-contributed to the misdirection
2
by ..chasing the .rabbit trail laid down by the Commissioner2
The majority steers us to section 408(h) to lash custodial
accounts and trusts together . See majority op . pp . 8-9 . That
section provides :
SEC . 408(h) . Custodial accounts .-- For purposes of this
section, a custodial account shall be treated as a trust if
the assets of such-account are held by ,a bank (as defined in
subsection (n)) or another person who demonstrates, to the
satisfaction of the Secretary ; that .. the manner~in which he
will administer the account will be consistent with the
requirements of this section, and if the custodial account
would, except for the fact that it is not a trust,
constitute an individual retirement . account described in
subsection (a) . [Emphasis added . ]
22 We . note, without opining on its consequences, that the
revenue ruling preceded by a few years Congress's 1996 and 1997
amendments to the S-corporation .- rules to provide that an employee
stock ownership plan (ESOP) under section 401 could be a
shareholder of an S corporation although the tax treatment of an
ESOP beneficiary is equivalent to that of a traditional IRA
owner ; and the income of an ESOP is taxed under-section 72 when
distributed to the beneficiary just like an IRA's is .
44 ` .The emphasized phrase confines section 408(h)'s equation of
trusts and custodial accounts to .section 408 . Section 408 places
limits on .IRAs on rollover contributions, on who can be,a .custo
dian, on what assets can be held in them, on whether they can be
forfeited, or on whether their assets can be commingled . Section
408(h) simply directs us to these other parts of section 408 .
.-And we really should have spotted the obvious point that
this revenue ruling--issued in 1992--is most unlikely to be helpful in deciding the meaning of a regulation issued three years
later . Revenue'rulings don't trump regulations . We thus agree
with Taproot that-Revenue Ruling 92-73's skimpy analysis, if
relevant at all, to this case, was overturned by the 1995 regulation and,the Commissioner's later analysis of S-Corporation ownership eligibility for ESOPs . See Rev . Rul . 2003-27, 2003-1
C .B . 597 .
C.
What really seems to lead the majority .to its conclusion i s
less the old revenue ruling and grantor-trust rules than its
extensive consideration of public policy and what it concludes
from the fact,-that "there is no indication that Congress ever
intended to allow IRAs to own S-corporation stock ." See majorit y
op . p .
19 . The majority first notes that IRAs are not explicitl y
listed,in .section 1361 as eligible S-corporation'shareholders .
,,This is-true, but the Supreme Court has repeatedly warned that
"congressional silence lacks persuasive significance ."
Gardner , 513 U .S . .115, 121 (1994) (citation omitted) ;
Brown v .
Wyeth v .
- .4 5
129S~.` Ct . 1187', 121.6 (2009) ("th e
relevance i's
not in :.any"inferences that the-Court may dra w
from congressional silence about the motivations or policies
underlying Congress' failure to act") ;
Rapanos v . United States ,
547 U .S . 715, 749 (2006) (noting the Court's "oft-expresse d
skepticism toward s reading the tea leaves of
congressiona l
inaction") .
The majority next argues that "had Congress intended t o
render IRAs eligible S-corporation shareholders, it could have
done so explicitly, as it has in the limited case of banks desiring to elect,S status ." See majority op .--p . 19 . The majority's reference hereis .to section 1361(c .)(2)(A)(vi), added t o
the Code in 2004 by the American Jobs Creation Act of 2004, Pub .
L . 108-357, sec . 233(a), 118 Stat .
1434
23
It .makes trust IRA s
eligible S corporation owners :
(vi) In the case of a corporation which is a bank (as
,defined in'sect'ion581)or;a-depository institution folding
company (as defined in section'3(w)(1 .) of the Federa l
Deposit'-Insurance Act (12 . P . S :: C 1813- (w) (1')) , a trust which
constitutes an individual retirement account under sectio n
23 Following this amendment,•~the Secretary"addedsubdivision (vii) to section 1 .1361-1(h)(-1)', Income Tax Regs .
"In the case of a corporation .which is ' a .bank v* •* * a trust .-which
constitutes an individual . retirement account under sectio n
:408 (a) , including" .one designated as a . Roth_ ' IRA .'under section
408A, but only to- the extent of the stock held by such trust in
. .
such bank or compny as .-of'October 22,'',2004 .' .i-Individual
retirement accounts (including Roth=IRAs) are not otherwise
. .
eligible :S corporation' shareholders ;'"m
While not ''an issue discussed by, the majority., note,that the
new r"egulation applies only to IRAs set up as trusts and may in
context apply only . .to- .banks,x,or,bank .. holding, companies organized
as S corporations . In any event, .`it applies only prospectively,
after the year involved here ..
- 46 408(a), including one designated as a Roth IRA under section
408A, but only to the extent of the stock held by such trust
.in such bank or,,-company as of the date of the enactment of,
this clause .
While we agree with the majority that the 2004 amendment was
a"very narrow exception that allows IRAs to hold shares in
S
corporation banks", see majority op . p . 20, we disagree with the
majority about its significance as a window into the mind o f
Congress on the general eligibility of S-corporation shareholders
to hold their stock in IRAs . First, the amendment had an exceptionally narrow focus . . It was limited to trusts and did not include custodial accounts like DiMundo's IRA . And its narro w
focus matched the narrow problem it was aimed at--existing shareholders of small banks who held their stock in IRAs . Even when
Congress amends parts of a statute, the Supreme Court has warne d
us .that "as a general matter *,* * [the] arguments [of congressional inaction] deserve little weight in the interpretive,process ."
Central Bank of Denver, N .A . v . First Interstate 'Bank of
Denver, N .A . , .511 U .S . .164, 187 (1994) . And the narrow. focus of
Congress's attention should make us even more cautious--"when, as
here, Congress has not comprehensively revised a statutory scheme
..but has made .only"isolated amendments, we have spoken more blunt-
ly : `It is "impossible to assert with any degree . of assurance
that congressional failure to act represents" affirmative
congressional approval of the Court's statutory interpretation ."'
Patterson v . McLean Credit Union , 491 U .S . 164, 175, n .1 (1989)
(quoting'Johnson v . Transp . Agency, Santa Clara County , 480 U .S .
616, 671-72 (1987) (Scalia, J ., dissenting) .
- 47 The GAO report quoted .so extensively by both the Commissioner and the majority only adds more ballast to . my emphasis on
the narrowness of this problem--the impact of .the old law o n
community banks . The amendment was simply a specific solutio n
offered to a particular problem, itself a consequence of a longtime ban on banks '
being . allowed to organize as 'S corporations
that Congress didn 't lift until 1996 .2 4
After 1996 ,
banks faced a costly and complicated process to
convert from being a C to an S corporation if they had employees
who had tucked their shares into IRAs .
Independent Community Bankers , of America
The chairman of the
( ICBA )
described th e
obstacles :
IRAs often hold significant portions of bank stock, thereby
limiting banks' ability to elect S Corporation status . In
many cases, banks find it virtually impossible to eliminate
the significant amount of stock owned by IRAs due to capital
constraints .
* * * [T]he owner of the IRA is a disqualified party and is
prohibited from purchasing thecommunity bank's stock from
the TRA . * * * IRAs that participate in prohibited transactions taint the entire fund and the tax exemption is : lost .
The account ceases to be an IRA on the first day of the
taxable year in which the prohibited transaction occur s
The Department of Labor has granted exemptions, on a
case-by-case basis, from the prohibited transaction rules
when the IRA wanted to sell stock to a disqualified party .
However, applications must be submittedfor each individual
case and are time consuming and expensive .
ICBA recommends allowing owners of IRAs holding the
stock of a community bank making the S•Corporation electio n
24 Small Business Job Protection Act . of 19 .96, Pub . L . .
104-188, sec . .1315, 110 Stat . 1785 (amending sec . 1361(b)(2)(A)) .
Before this Act, banks couldn't be S corporations .
- 48 to purchase the subject securities from the IRAs . This can
be accomplished by amending IRC §4975 or IRC §408 to alleviate the penalty associated with an IRA selling one of its
assets to its owner .
Hearing on .S Corporation Reforms Before the Subcomm . on Selec t
Revenue Measures of . the House Comm . onWays and Means, 108t h
Cong ., 1st Sess . 41-42 (2003) (statement of C .R . "Rusty"
Cloutier, President and Chief Executive Officer, MidSouth Bank,
Chairman of the Independent Community Bankers of America) (fn .
refs . omitted) .
The GAO focused on this problem and consulted legal an d
accounting experts, Treasury officials, and others solely on the
cost and delays of eliminating IRA shareholders when a bank
converted to S status . And while the GAO's Report did note "IRAs
are not eligible to be S-corporation shareholders under present
law, ,25
GAO Report, app . IV at 47, nowhere did it cite any
authority for this contention (though it's reasonable to assume
.it had . Revenue Ruling 92-73 in mind) .
The .Secretary responded to the GAO study in a short letter .
He referred to "a series of proposals related to banks organized
as S corporations" and commented that his discussion was limited
to the particular subject of the potential impact of the proposal
on community banks . He then went on to address the specifi c
problem :
The prohibition of IRAs as shareholders also creates
difficulties only for banks that had been previously
organized as C corporations . * * * It is important to
emphasize in the text of the report that a substantia l
25 GAO Rep . at '47 .
- 49 number of banks are already operating as S corporations, and
therefore have presumably not found these provisions, which
are necessary in our view for the reasons discussed above,
insurmountable .
GAO Rep . at 61 .
The most interesting part of Treasury's response is its
suggestion that the real problem with S corporation shareholders'
putting their stocks in IRAs was the possibility that the corporation's operating profit might go .untaxed for quite a while :
Treasury officials generally opposed this proposal because
permitting IRAs to hold shares in S corporation banks would
create untaxed income for a potentially long period of time .
Id .
at 6-7 .
Treasury indicated that if IRAs were allowed to be S
corporation shareholders, from a policy standpoint, the
Unrelated Business Income Tax should be imposed, which
parallels similar tax treatment of other pension funds .
Id .
app . IV, at 49 .
The Deputy Assistant Treasury Secretary for Tax Policy
repeated those concerns :
Our support, however, is explicitly conditioned on the S
Corporation income earned in the IRA being treated as
unrelated business taxable income . We are concerned that,
if enacted, subsequent efforts will be made that would make
such income not subject to UBIT (as was done in the case of
ESOPs), . thus eliminating any and all tax on such income .
Hearings,
supra
at 19 (statement of Gregory F . Jenner, Deputy
Assistant Secretary for Tax Policy, U .S . Department of th e
Treasury) .
Since the
2004 amendment, several Congressmen . have intro-
duced bills to allow S-corporation stock to be held in IRAs of
50 all types, . The majority, see majority op . note 25, . cites the
failure of these efforts as additional support for inferring
a
prohibition on owning S corporation stock in IRAs .
But asking why Congress hasn't amended the Code to reverse
Revenue Ruling 92-73 isn't the right way to look at the problem .
In a system like tax law, so heavily dependent on regulations t o
fill the'irievitable gaps, the right questions are what does a'
regulation . mean and does it stay within the boundaries marked out
in the Code . ;
Chevron doesn't tell us to ask why Congress didn't
.do what the regulation does ; it tells us to ask whether the
regulation is valid as a reasonable interpretation of an ambiguity in the Code .
Redlark v . Commissioner , 141 F .3d 936, 939 (9th
Cir . 1998),,revg . 106 T .C . 31 (1996) ;
Commissioner , 126 T .C .
Swallows Holding, Ltd . v .
96, 157 (2006) (Halpern, J . dissenting),
vacated 515 F .3d 162 (3d Cir . 2008) . Here, the ambiguous term in
the Code is "individual" in section 1361(b)(1)(B) and, as explained above, the regulation is a perfectly reasonable construction of that term ., If, as also explained above, a custodial account is not a person, but,a way a person can own property, the n
the regulation as-applied certainly allows DiMundo to hold his
,stock in a custodial account, even an IRA .
The majority's approach also veers toward relying on . the
doctrine of legislative reenactment, when it argues that Congress
has to have been aware of the IRS's revenue ruling and PLRs but
chose not to amend the Code in response . Yet there is no evidence,that Congress knew of any Code section or regulation or
51 revenue ruling or even .PLR°on this matter .- This should have
started caution flags fluttering . "The're-enactment doctrin e
* * * is most useful in situations where there is some indicatio n
that Congress .noted or considered,,the .regulations-i-n effect at
the time of its action . Otherwise, the doctrine may be as
doubtful as the silence of the, statutes and 'legislative history
to which it is applied ." - Peoples Fed Sav .-&_Loan .Association v .
Commissioner , 948 F . .2d 289,1 302-03 (6th .Cir . 1991), revg . T .C .
Memo . 1990-129 :
III .
But there remain two questions that seem to really troubl e
the majority : Why is it only now that anyone is making this
argument? And wouldn't the system fall apart if people coul d
hold S corporation shares in their IRAs ?
Whenever a novel legal argument . about an old law is proposed, a prudent judge should ask why no one's ever thought of it
before . But whatever .'presumption of incorrectness novelty mus t
bear., it can't be a complete bar . 2 6
26 "Two University of Chicago Nobel laureates walking down
a campus sidewalk . One says to the other, `There's a $20-bill on
Without looking down, the other
the sidewalk .in front of you .,
laureate retorts, `No there isn't .' To which the first laureate
says in some frustration, `Well,, look down . It's r .ight'there!'
The second laureate then closes off the debate *`* * `There
couldn't be . If there were a $20-bill on .the sidewalk, someone
would have picked it up . McKenzie, Book Overview : A Defense of
Rational Behavior in .Economics, ch .=1, at 3 (Merage School of
.Busin-ess, Univ . of Cal• ., Irvine (under development in 2008) (bu t
, .based on a long-oral tradition) . On.-the hazards of picking up
money from sidewalks,. see generally, Roberts v . State , 12 P .2d
(continued . . .)
52 And there's . a'reasonable explanation for no one's having
raised the argument till now . To understand it, consider the
.question's chronology :
1958--Subchapter S corporations put in the Code--ownership
limited to individuals and estates2 7
1966--Revenue Rulings 65-90 and 66-266 allow minors or
others under disabilities, whose property is held in-,
custodial accounts or by estates, to be eligible S
corporation .~shareholders2 8
1974--Traditional IRAs put in the Code29
1976--Grantor trusts allowed to be S-corporation
shareholders3 0
1992--Revenue Ruling 92-73 holds that an IRA held by a
trust .is .not a trust eligible to be an S-corporation ;
shareholder3 1
1995--Section 1 .1361-1(e)(1), Income Tax Regs ., is issued .3 2
26 ( .
.
.continued )
(Okla . Crim . App . 1931) ;
1922) . .
Atkinson v . Birmingham , 116 A . 205 (R .I .
27 Former secs . 1371 -1377 were first added to the Code by
the Technical Amendments Act of 1958 , Pub . L . 85-866, sec . 64, 72
Stat . 1650 .
28 Revenue Rulings 65-9 .0, 1965-1 C . B .
1966-2 C .B . 356 .
428, and 66-266,
29
Employee Retirement Income Security Act of 1974, Pub .
L . 93-406,,sec . 2002(b), 88 Stat . 959 . Sept . 2, 1974 .
30. Tax Reform Act of 1976, Pub . L . 94-455, sec .
902 (c) (2) .(A)`, 90 Stat ., 1609 .
31 Revenue Ruling 92-73, 1992-2 C .B . 224 . .
32
T .D . 8600, 1995-2 C
.B . 135, (July 21, 1995) . Former
.section 1 .1371-1(d)(1), Income Tax Regs ., issued under former
Code section 1371, provided that partnerships and trusts and not
their partners or beneficiaries were treated as the shareholders .
.In 1995, . the Secretary changed position . and promulgated section
1 .1361-1, Income Tax Regs ., partially allowing more flexible S(continued . . .)
53
1996--Banks are allowed to be organized as .S corporations "
1997--Roth IRAs are put in the Code3 4
2004 -- IRAs already owning shares in banks converting to S
corporation status are expressly made eligible
shareholders .3 5
This is a history of adhocery--Congress and the IRS finding
solutions to new problems in the area as they arose . What makes
the 1995 regulation so significant is that . it marked the first
time that the Secretary chose to stop tweaking the list o f
eligible S-corporation shareholders, and instead set up a general
principle for dealing with a class of situations where variou s
32( . . .continued)
corporation"ownership and possession. The Secretary put some
extra thought into this . When first proposed, the regulation
provided'that in the case of- a• partnership "the partnership (and
not its partners) is considered to be the shareholder and the
corporation does not qualify as a small business corporation ."
-Following comments that questioned why stock held by a partnership as nominee could not be considered~to'be owned by the bene
ficiary, the Secretary reversed course and the final regulations
provided-that the .person-for'Whom a .partnership holds S-corporation stock will be treated as the shareholder . T .D . 8600, 1995-2
C .B . at 136 (July 21, 1995) . His explanation for including partnerships on the list of eligible shareholders, particularly when
other flowthru entities were also added over the years, suggests
that preserving the "tax dynamics" of S-corporation distributions, see Halpern, J . concurring . op °notel .f was not his primary
goal .
33 Small Business Job Protection Act of 1996, Pub . L .
104-188, sec . 1315, 110 Stat .'1785 (amending sec . 1361(b)(2)(A)) .
34 Taxpayer Relief Act of 1997, Pub . . L . 105-34.,
302(a), 111 Stat . 825 .
sec .
35 The American Jobs Creation . Act of 2004, Pub . L .
108-357, sec . 233(a), 118 Stat . 1434, added that provision to .
sec . 1361(c)(2)(A) .
- 54
entities exercised different attributes of ownership--title,
possession, etc .
The problem is that the parts of the IRS overseeing IRA law
don't seem to have-noticed this turn taken by the parts of the
IRS overseeing S-corporation law . Treatise writers have noticed,
but have nevertheless cautioned tax planners against taking the
risk of challenging the Service, given the stakes involved . See
Eustice & Kuntz,
tion s
supra par . 3 .03[9] ; Blau et al ., 1 S Corpora-
Federal Taxation par . 3 .30 (2009) . One can understand this
caution--having even one ineligible shareholder triggers revocation of S-corporation status, sec . 1361(b)(1), with, its immediate imposition of a second layer of taxation on profit distributions to the shareholders . This makes the absence of precedent
on the question understandable--for a corporation that ,has share,holderswho .have put their stock . in an IRA, electing S-Corpora
tionstatuscould ;trigger excise tax on excess contributions,
sec . 4973 ; penalties on prohibited transactions, sec . 4975 ; and a
.tax on distributions from the affected corporation that will
.apply to all . its shareholders .
B.
There is,, finally, the objection that by allowing S-corporation stock to be held in tax-deferred or tax-exempt IRA accounts ,
"tax alchemy in a free enterprise business context could be ,
achieved . .,, This would grant an overwhelming competitive tax benefit to a Roth IRA-owned business compared to a C corporatio n
,competitor who is subject,to :two levels of tax--one at the-cor
55 porate level and another at the shareholder level ." See majority .
op . note 18 . But this underestimates the strengths of the Code's
other defenses against such shenanigans . There are numerous limitations on what can go in and out of an IRA--income-contribution limits, sec . 219 ; deadlines for contributions, sec . 219 ;
penalties on prohibited transactions, sec . 4975 ; penalties on excess contributions, sec . 4973 ; etc .36 But even more importantly,
while custodial retirement accounts are generally exempt from tax
on undistributed IRA income, they are still "subject to the taxes
imposed by section 511 (relating toimposition of tax on
unrelated business income of charitable, etc . organizations) ."
Sec . 408(e)(1) .
It's UBIT, not the revocation of S-corporation status, that
plugs .any loophole . While IRAs normally may hold a variety of
investments including cash, stocks, and bonds, they are exempt
from tax on income derived from such investments . This cluster
of Taproot-like cases all seem to feature investments such as
real-estate and other small businesses that would generate UBIT .
See sec . 512(a)(1) ; see also supra note 9 .
That is certainly what seems to have been happening in this
case and the two related to it . The oral settlement in DiMundo
v . Commissioner , docket No . 15395-07, included DiMundo's conces-
36 Ignoring such constraints is presumably what led the
Commissioner to consider some schemes involving S corporations
and ESOPs to be abusive tax transactions under section 409(p) .
The Secretary made them "listed transactions" under the tax
shelter regulations, including its disclosure requirements . See
Notice 2004-8, 2004-1 C .B . 333 (Jan . 26, 2004) .
56 sion of the penalty owed for making excess contributions to . an
.IRA . under section 4973, as well as his concession that he received nearly a million dollars in unreported taxable dividends
from the operating business standing in back of Taproot that
flowed into his custodial account . Itreally would be tax alchemy if such operating profits went untaxed in an IRA . But the
solution is what the parties came up with here--a recognition
that whether taxed as unrelated income or deemed dividends, the
income would nevertheless be taxed .
They did have $8,549 of what they called interest left over,
and stipulated to the Court that resolution of this summaryjudgment motion would govern whether that trickle of an income
stream would be taxed as C-corporation income or flow through to
DiMundo's Roth IRA . The practical effect of ruling against the
government here would likewise be much smaller than the majority
fears, given the breadth of the income that is subject to UBIT .
7 Fed . Tax Coordinator 2d (RIA), pars . D-6916 .1, D-6901 (2009)
(characterization of the income and loss from S corporation to
.tax-exempt organization as unrelated business income applies
regardless of the nature of such income . )
This case is a reminder that tax law does not cascade into
the real world through a single channel . It meanders instead
through a vast delta, and any general principles tugged along by
its current are just as likely to sink in the braided and rebraided rivulets of specific Code provisions and the murk of
regulations as they are to survive and be useful in deciding real
57
cases . Taproot thinks it found a course through the confluence
of the subchapter S and IRA rules that it could successfully
navigate . Its route would-be new,, but the stakes are not that
great, and the sky will remain standing if we had just read an d
applied the regulation as it' .is :
I respectfully dissent .
FOLEY, KROUPA, and MORRISON, JJ ., agree with this dissenting
opinion
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