Can an IRA Own S Corp Stock?
IRAs and S corporations are popular for their tax benefits. IRAs are popular because all income and gains can be deferred for tax purposes and S corporations because they allow investors to avoid the double taxation that normal corporations face. An astute investor may consider trying to hold S corporation stock in an IRA to “double up” on the tax benefit. However, case law as of 2011 prevents investors from participating in this type of tax planning.
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S Corporation Defined
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An S corporation is a special business entity defined by the tax code. While incorporated under state law like a normal corporation, this type of entity can apply to the IRS to qualify as a “pass-through” entity. This allows the stockholders to be taxed directly on their “share” of the business’s income and deductions, as defined by their percentage ownership in the company. As the S corporation is organized under state law, it has the same legal liability protections as a regular corporation. In exchange for these benefits, the IRS places limitations on how the S corporation is organized. Specifically, an S corporation is allowed to have a maximum of 100 owners. The shareholders must be individuals, certain type of trusts or estates. Business organizations, such as partnerships and corporations, and nonresident aliens cannot own stock in an S corporation.
IRA Defined
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An individual retirement account (IRA) is a special type of investment vehicle that grants individuals tax benefits as they invest in retirement. There are three different types of IRAs: the traditional, Roth, and the simplified employee pension plan (SEP). A traditional IRA allows you to defer taxes on all gains and dividends the investments in the IRA generate until withdrawn. A Roth IRA requires that you only contribute money and investments that have already been taxed, but if you wait until you are 59 1/2 to withdraw the investments, any gains or income generated by the initial investment will not be taxed. Individuals can contribute only limited amounts to the traditional and Roth IRA, as defined by the IRS. The SEP is an IRA that allows employers to make contributions to the fund.
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S Corporations and IRAs
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The relevant tax code does not expressly prohibit IRAs from owning S corporation stock. However, in cases on this issue the U.S. Tax Court has determined that IRAs cannot own shares in an S corporation. This stance agrees with the position that the IRS has taken regarding this issue. The main reason IRAs are prohibited from holding S corporation stock is that they defer recognizing income generated from their investments. The purpose of the S corporation is to allow taxpayers to be taxed on their share of the business’s earnings in the year it is earned. If S corporation stock could be held by an IRA, portions of the business’s earnings could be tax deferred for long period of time. If the stock were in a Roth IRA, the income may never be taxed. The Tax Court found this to be inequitable and against the spirit of the purpose of an S corporation.
Considerations
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The case law that prohibits S corporations from owning S corporation stock could be overturned by an act of Congress amending the tax code or a Supreme Court ruling. If you are considering forming an S corporation, consult with an attorney or a certified public accountant in your area to ensure that you comply with all filing requirements. While every effort has been taken to ensure that this article’s completeness and accuracy, it is not intended to be legal advice.
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