Tuesday, September 2, 2014

Hog Gets Slaughtered - Roth IRA Not Qualified To Hold S Stock

Originally Published on forbes.com on March 28th,2012
Roth IRA’s have been in the news lately as some entrepreneurs have managed to shelter large stock gains from public companies they were involved in. Yelp founderMax Levchin recently sheltered a 10 million dollar gain.  So here is a neat idea.  Why not have the Roth own stock in an S Corporation ?  Then you could avoid corporate income tax also.  There are a number of reasons why this might be a bad idea, but the fundamental one that comes to mind is that a Roth IRA is not qualified to hold S Corporation stock.  If a single share of stock in an S Corporation is owned by a disqualified shareholder, the S election is blown.  Is a Roth IRA qualified to hold S Corporation stock ?  I thought not.  Taproot Administrative Services, Inc thought otherwise.
I usually root for the taxpayer, but this case was an exception.  When I think it borders on the self-evident that a favorable tax plan does not work and it turns out that it does, I am very embarrassed.  As it turns out the Tax Court and now the Ninth Circuit agreed with me.  There is a lot of lawyerly refutation of Taproot’s theories as to why it should work, but the answer boils down to Roth IRAs not being on the list of eligible shareholders.  There is something mysterious about this case.  Look at this:
According to its 2003 tax return, Taproot earned a total income of $322,420. Taproot reported total deductions of $320,191, resulting in a net ordinary income of $2,229. Taproot also reported interest income totaling $8,549.
Then there is this corporate record.  Even though it says Tap Root rather than Taproot, I am fairly certain it is the same company that was dissolved in 2005 based on the name of the officer. (Paul Dimundo, President, Treasurer, etc according to the record is also mentioned in the case as the Roth holder.)  That would have raised other issues if the IRS had not gone after the one that they chose, but that is neither here nor there.
So here is the mystery. Why would somebody go to Tax Court and then appeal to the Ninth Circuit over a couple of thousand dollars of liability of a dissolved coporation ?  Sadly, I am a tax blogger, not an investigative reporter, so I think I will remain baffled.  My theory is that if the plan had stood up, it would have been marketed. Anybody else have any ideas ?
You can follow me on twitter @peterreillycpa.

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