Corporations are generally subject to federal income tax on their taxable income, when earned, and shareholders are generally subject to federal income tax on the receipt of dividend distributions from corporations, but only when such distributions are actually made. In the case of a corporation meeting certain criteria, the Internal Revenue Code offers the option of electing “S corporation” status, under which the corporation is generally not subject to federal income tax, but the shareholders are subject to tax on a “pass-through” basis at the time the corporation earns income, regardless of whether the income is distributed to them. The income of an S corporation is thus generally taxed currently to all of its shareholders, including qualified pension trusts and charitable organizations that would otherwise be exempt from income tax.
The rules governing what sorts of trusts are—and are not—permitted to be shareholders of an S corporation are extremely detailed. As noted above, qualified pension trusts and charitable organizations are also specifically permitted to be S corporation shareholders. In a recent reviewed decision, the Tax Court held (with four judges dissenting), that a Roth individual retirement account (“Roth IRA”) is not a permitted shareholder of an S corporation and, therefore, that a corporation in which a Roth IRA held shares could not qualify as an S corporation, but, rather, was fully taxable as a “C corporation.”1
