chevron-down Created with Sketch Beta.
November 02, 2011 The Tax Lawyer

Recognizing Roth IRAs as S Corporation Shareholders: A Critique of Taproot v. Commissioner

Vol. 64, No. 3 - Spring 2011

Shannon Tucker


    Individuals planning for retirement often set up a Roth Individual Retirement Account (Roth IRA) to manage savings and take advantage of government provided tax benefits. Roth IRAs provide taxpayers with a wide range of freedom to manage the account’s structure and investment scheme. In Taproot Administrative Services v. Commissioner, a strongly divided Tax Court limited that freedom by holding that Roth IRAs cannot be shareholders of S corporations. The majority relied heavily on a revenue ruling and did not consider applicable Code provisions or the impact of unrelated business income tax (UBIT) on Roth IRAs. At its base, the Taproot decision reveals an unfounded fear that allowing taxpayers with Roth IRA shareholders to elect S corporation status will result in the use of illegal tax shelters. The court limited Taproot’s freedom of form without a clear statutory basis, contravening Supreme Court precedent that taxpayers have a legal right to structure their affairs and even minimize or avoid taxes by any means that the law permits. The majority’s holding is undermined by statutory law, legislative history, and congressional intent, which suggest that Roth IRAs are in fact permissible S corporation shareholders and that UBIT provides a mechanism for proper taxation.

    Taproot presented a legal issue of first impression to the Tax Court and is appealable to the Ninth Circuit. Taproot was not alone in its struggle to be an S corporation with a Roth IRA shareholder; it was chosen to be the test case for almost one hundred similar cases pending before the Tax Court in fall of 2009.

    This Note reveals the flawed policy basis upon which Taproot rests by examining the governing statutory law and judicial decisions, administrative pronouncements, and legislative history. Part II of this Note gives a brief description of crucial terms, legislative history, and the relevant statutes and regulations governing Roth IRAs and S corporations. Part III outlines the facts of Taproot, explains the court’s decision, and addresses the court’s underlying policy goals. Part IV argues that the majority’s decision disregards governing Code provisions and regulations, ignores statutory mechanisms already in place to guard against tax shelters, and ultimately oversteps its authority by preemptively invalidating an election that Congress has shown no intent to proscribe. Part V concludes by rejecting the court’s decision in favor of a more convincing Code interpretation that best serves the court’s fundamental policy aims.

Read the full article or download the complete issue.