                       133 T.C. No. 9



                UNITED STATES TAX COURT



 TAPROOT ADMINISTRATIVE SERVICES, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



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.
                               - 2 -

                              OPINION


     WHERRY, Judge:   This 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




     1
      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.
     2
      The Form 1120S indicates that petitioner’s S election was
effective Oct. 2, 2002.
     3
      The account was held at the First Trust Co. of Onaga in
Onaga, Kansas.
                                - 3 -

     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 because it had

an ineligible shareholder.   Petitioner filed a petition with this

Court on July 6, 2007.   Respondent moved for partial summary

judgment on the issues of whether petitioner is eligible 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.

                             Discussion
A.   Summary Judgment

      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 Eligibility

     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 election




     4
      Although 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 investment
income. See secs. 1374(a), 1375(a).
                                - 5 -

terminates on the date on which the ineligible shareholder

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 2003 and should be taxed as a C

corporation for that year.

       The S corporation eligibility rules, which focus on both the

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.
                                - 6 -

               (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.    In the Tax

Reform Act of 1976, Pub. L. 94-455, sec. 902(c)(2)(A), 90 Stat.

1609, Congress amended subchapter S to allow certain trusts to

own S corporation stock.    In the Small Business Job Protection

Act of 1996, Pub. L. 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.5    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




     5
      The 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 the
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. 501. Petitioner does not argue to the contrary.
                               - 7 -
stock is held in a trust that qualifies as an IRA or a Roth IRA.

See sec. 1361(c)(2)(A)(vi).6

C.   IRAs7

     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 business




     6
      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). 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.
     7
      Although 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.
                                 - 8 -
income), and (3) the inclusion of distributions in gross income.8

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.

408A(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.




     8
      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).
     9
      The 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 IRA
and are not included in gross income and are therefore not
subject to Federal income tax.
                                 - 9 -

In that case, they must be treated as trusts in order to qualify

as IRAs.    See sec. 408(h).   In other words, a custodial account

IRA must be treated as a trust in order for it to qualify as an

IRA under section 408.

D.   Parties’ Arguments

     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 the

shareholder 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 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.”    Petitioner also cites Rev. Rul. 66-266, 1966-2 C.B.

356, and Priv. Ltr. Rul. (PLR) 86-05-028 (Nov. 4, 1985)10 for the

proposition that S corporation stock held in a custodial account

for a disabled person or by a custodian under the Uniform Gifts




     10
      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); Magdalin v. Commissioner, T.C. Memo. 2008-293
n.7.
                              - 10 -
to 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 by

an individual who is a citizen or resident of the United

States.”11

     Respondent argues that “an IRA custodial account is very

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. 92-

73, 1992-2 C.B. 224, in which the Commissioner concluded that a

trust that qualifies as an IRA is not a permitted shareholder of

an S corporation.




     11
      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 Shareholders12

      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 only

legal authority specifically addressing the issue was Rev. Rul.

92-73, supra.14   Thus, the legal issue presented in this case is

one of first impression in our Court.

      1.   Deference to Revenue Rulings
      “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.




      12
      That is, except for the limited transitory relief
explicitly authorized by Congress vis-a-vis S corporation banks.
See supra p. 6.
      13
      Recently 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.
      14
      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 Schuylkill
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 afford

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   The


     15
      See, 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.
     16
      In 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. at 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 banc) (“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 I.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.   Persuasiveness of Rev. Rul. 92-73

     The rationale underlying Rev. Rul. 92-73, supra, is

straightforward--traditional IRAs are not eligible S corporation

shareholders because the beneficiary of a traditional IRA is not

taxed currently on the IRA’s share of the S corporation’s income

whereas the beneficiaries of the permissible S corporation

shareholder trusts listed in section 1361(c)(2)(A) are taxed

currently on the trust’s share of such income.17

     The revenue ruling’s rationale sensibly distinguishes IRAs

from grantor trusts governed by sections 671-679.18   “When a


     17
      Rev. 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 the
                                                   (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 ‘looks 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 accrue

tax free in both entities.19   It follows that the tax


     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.
     19
      When 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).20


     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 tax-
exempt 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.
     20
      Whether 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 of
                                                   (continued...)
                               - 17 -

     We also note that, as a technical matter, traditional and

Roth IRAs do not appear to be grantor trusts 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 from their owners for

Federal income tax purposes.   Were that not the case, Congress

would not have needed to subject IRAs to the unrelated business

income tax (UBIT).21



     20
      (...continued)
determining S corporation shareholder eligibility. Unlike 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’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 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 some time 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 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.
     21
      The 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, affd. 193 F.3d 1098 (9th Cir.
1999). The Internal Revenue Code imposes UBIT on tax-exempt
organizations, including IRAs. See sec. 408(e)(1). If 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 Estate of O’Connor v. Commissioner, supra at 174;

see also 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 its

grantor or beneficiary--owns the IRA’s income and gains, and




     22
      In 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. 1.671-4(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 Federal income tax (except

when UBIT is triggered).

     Finally, since issuing Rev. Rul. 92-73, supra, the

Commissioner has applied it consistently to all IRAs.    For

example, the Commissioner regularly invokes Rev. Rul. 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. 2008-45-037 (July 31, 2008);

Priv. Ltr. Rul. 2005-01-013 (Sept. 29, 2004).

     3.   Other Compelling Reasons To Reject the Legal
          Interpretation Petitioner Advocates

     Of more significance than Rev. Rul. 92-73, supra, is the

fact that there is no indication that Congress ever intended to

allow IRAs to own S corporation stock; the only available

evidence suggests otherwise.   To begin with, IRAs are not

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 it

has in the limited case of banks desiring to elect S status.    See

Traynor v. Turnage, 485 U.S. 535, 547 (1988) (“If Congress had
intended instead that primary alcoholism not be deemed ‘willful

misconduct’ for purposes of § 1662(a)(1), as it had been deemed


     23
      If an S corporation’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 Community 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 section

1361(c)(2)(A)(vi) in 2004.   See supra note 6.    That provision is

a very narrow one.   It permits traditional and Roth IRAs to be

shareholders of S corporation banks, but only to the extent of

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 belief

that IRAs were ineligible S corporation shareholders.    See H.

Rept. 108-548 (Part 1), at 129 (2004) (“Under present law, an IRA

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 mere

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 this

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 is


     24
      Although 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)).
     25
      On 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, petitioner

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
      (...continued)
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 proper

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, either

deferring taxation of (what is still pretax) income (traditional

IRA) or exempting that income entirely (Roth IRA).1   For that

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 custodial

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 that




     1
      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.
     2
      Judge 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 regu-

lation states that “[t]he person for whom stock of a corporation

is held by a * * * custodian * * * is considered to be the share-

holder of the corporation.”1   The First Trust Company of Onega is

a custodian.   DiMundo would therefore seem to be the person who

is considered to be Taproot’s shareholder.2   Since he is undoubt-

edly an individual, why exactly is it that Taproot is disquali-

fied 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 phras-

ing 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
         Sec. 1.1361-1(e)(1), Income Tax Regs.
     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 benefit 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 make
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 Congresses

thought previous Congresses had decided, or even what some agen-

cies told Congress the IRS thought that previous Congresses had

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 not * * *

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.

     4
            See majority op. p. 11.
     5
            See majority op. pp. 18-19.
     6
            See majority op. p. 19.
                              - 29 -

Memo. 1998-259, affd. 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 per-

son?”--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 filled this 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.
     * * * [Id.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”), does
                                                   (continued...)
                               - 30 -
     The Code doesn’t define “custodian”, but the dictionary

definition is “one entrusted officially with guarding and keep-

ing.”    Merriam Webster's Third 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) (custo-

dian 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 ac-

counts 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 is not enough,

of course, for it to qualify as an S corporation.   Let us go 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 is

held?”    The italicized phrase from the last sentence in the ex-

cerpt leads me to read the regulation as equating “beneficial

     7
     (...continued)
tell us who qualifies as a shareholder, and expressly includes in
the list anyone who counts as a shareholder under section 1.1361-
1(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 bene-

ficial owner depends upon the terms of his contract with the cus-

todian and applicable local law.    We recently held, for example,

that although a partner had title to a partnership interest he

was not its beneficial owner because the income from the partner-

ship 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 rather than technical legal title is con-

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 is

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 litiga-

tion 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, de-

termines 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) (“‘share-

holders’ who must file a consent are not necessarily ‘sharehol-

ders of record’ but rather beneficial owners of shares”), affg.

in part and revg. in part 51 T.C. 337 (1968); Danenberg v.

Commissioner, 73 T.C. 370, 390 (1979) (beneficial ownership

controls); 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 benefici-

ary.    As applied to this case, then, section 1.1361-1(e)(1), In-

come 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 ag-

ent (Onega) is considered to be the shareholder of an S corpora-

tion (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 majority

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 hold

S corporation stock in their own names--has been superseded by an

expanding list of exceptions, stretching from tax-exempt organi-

zations (under sections 401(k) and 501) to ESOPs, QSSTs, trusts,

corporations, and partnerships.

     The 1966 revenue ruling was important at the time for start-

ing 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, custo-

dian, 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 supports

the taxpayer’s position here.8

     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); Deppisch v. United States,

227 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. Unlike

     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's
     income, not the beneficiary’s.

See majority op. note 20.   I don't think this is right--a custo-

dial IRA is an account, not a trust--and while it is certainly a

method of owning something, it’s not obvious that a custodial

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 Black-

acre 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 custo-

dian.   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 accumula-
     ted 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 some time in the future, that does not make the IRA a
     “nominee, guardian, custodian, or an agent” of the benefici-
     ary 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(l)(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) for




     9
          UBIT is a tax imposed by section 511 on the income of
otherwise tax-exempt entities derived from a trade or business
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;11 he can combine IRAs to

satisfy the minimum distribution requirements under section

408(a)(6);12 he can replace the custodian at any time;13 he is

      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.
Ltr. Rul. 80-10-028 (Dec. 11, 1979). We don’t rely on this
ruling, since the Code forbids us from relying on private letter
rulings as precedent, even those cited by both parties (and
discussed briefly by the majority). See sec. 6110(k)(3).
      11
          “The Depositor agrees to provide the Custodian with all
information necessary to prepare any reports required by section
408(i) and Regulation sections 1.408-5 and 1.408-6.” Southwest
Securities, Inc., Individual Retirement Custodial Account Agree-
ment and Disclosure Statement (2002) (SWS), par. 5.01,
http://www.wisconsindiscount.com/pdfs/IRAAgreement05_06.pdf.
see also Fidelity Investments, Fidelity IRA and Roth IRA
Custodial Agreements (2009) (Fidelity), art. V (IRA) and art. VI
(Roth), http://personal.fidelity.com/accounts/pdf/custodials.pdf.

      12
        “The owner of two or more traditional IRAs may satisfy
the minimum distribution requirements described above by taking
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/AMTD401.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 removal
                                                   (continued...)
                                - 38 -
himself responsible for any fees, taxes and administrative

expenses;14 and he directs and controls the investments in the

account.15    Such agreements--while obviously not controlling here-

-at least suggest in their apparent uniformity that custodial-

account 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 the

     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 Depositor
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 investment 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 have
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 by
reference of recordkeeping duties like those found in section
                                                   (continued...)
                              - 39 -
beneficial enjoyment of the account.   And the regulation itself

lists other entities or exempt organizations as eligible owners

of S corporation stock.17

     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 simply a facilitator without beneficial ownership of the S



     16
      (...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 or the beneficiary of an IRA are
considered the S corporation shareholders, T.D. 9422, 2008-2 C.B.
898.
                               - 40 -
corporation stock, the exempt party generally should not be

treated as a shareholder for purposes of the allocation of

income.”)18

     So we have a regulation whose validity is unchallenged by

either the majority or the Commissioner.19   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 stock

ownership20 and gives us a reasonable answer to the question of

      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 in
                                                   (continued...)
                               - 41 -

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 constru-

ing that language.

     I tag along.

                                 II.

     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 eligibility.

     20
      (...continued)
Christian & Grant, Subchapter S Taxation, 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.
                                - 42 -

     The three themes flowing through the majority opinion--

deference 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, all

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 the

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)(1) 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 de-
     scribed in section 1361(c)(2)(A)(i) because the rules that
     apply to a trust described in section 1361(c)(2)(A)(i) or
     QSST 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 the

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. Galloway, 308 Bankr. 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.

                                  B.

     The majority’s lengthy discussion, see majority op. pp. 14-

18, 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

by chasing the rabbit trail laid down by the Commissioner).22

     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 help-

ful 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 regula-

tion and the Commissioner's later analysis of S-Corporation ow-

nership eligibility for ESOPs.   See Rev. Rul. 2003-27, 2003-1

C.B. 597.

                                 C.

      What really seems to lead the majority to its conclusion is

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 majority

op. p. 19.   The majority first notes that IRAs are not explicitly

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.”     Brown v.

Gardner, 513 U.S. 115, 121 (1994) (citation omitted); Wyeth v.
                              - 45 -

Levine, 555 U.S. ___, ___, 129 S. Ct. 1187, 1216 (2009) (“the

relevance is * * * not in any inferences that the Court may draw

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-expressed

skepticism towards reading the tea leaves of congressional

inaction”).

     The majority next argues that “had Congress intended to

render IRAs eligible S-corporation shareholders, it could have

done so explicitly, as it has in the limited case of banks de-

siring to elect S status.”   See majority op. p. 19.   The major-

ity’s reference here is to section 1361(c)(2)(A)(vi), added to

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 IRAs

eligible S corporation owners:

          (vi) In the case of a corporation which is a bank (as
     defined in section 581) or a depository institution holding
     company (as defined in section 3(w)(1) of the Federal
     Deposit Insurance Act (12 U.S.C. 1813 (w)(1)), a trust which
     constitutes an individual retirement account under section

     23
          Following this amendment, the Secretary added
subdivision (vii) to section 1.1361-1(h)(1), Income Tax Regs.
“In the case of a corporation which is a bank * * * a trust which
constitutes an individual retirement account under section
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 October 22, 2004. Individual
retirement accounts (including Roth IRAs) are not otherwise
eligible S corporation shareholders.”

    While not an issue discussed by the majority, note that the
new regulation applies only to IRAs set up as trusts and may in
context apply only to banks 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 of

Congress on the general eligibility of S-corporation shareholders

to hold their stock in IRAs.   First, the amendment had an excep-

tionally narrow focus.   It was limited to trusts and did not in-

clude custodial accounts like DiMundo’s IRA.   And its narrow

focus matched the narrow problem it was aimed at--existing share-

holders of small banks who held their stock in IRAs.   Even when

Congress amends parts of a statute, the Supreme Court has warned

us that “as a general matter * * * [the] arguments [of congres-

sional inaction] deserve little weight in the interpretive pro-

cess.”   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 Commis-

sioner and the majority only adds more ballast to my emphasis on

the narrowness of this problem--the impact of the old law on

community banks.   The amendment was simply a specific solution

offered to a particular problem, itself a consequence of a long-

time ban on banks’ being allowed to organize as S corporations

that Congress didn’t lift until 1996.24

     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.    The chairman of the

Independent Community Bankers of America (ICBA) described the

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 the community bank's stock from
     the IRA. * * * IRAs that participate in prohibited transac-
     tions 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 occurs . .
     . . 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 submitted for 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 election


     24
          Small Business Job Protection Act of 1996, 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 allevi-
     ate the penalty associated with an IRA selling one of its
     assets to its owner.

Hearing on S Corporation Reforms Before the Subcomm. on Select

Revenue Measures of the House Comm. on Ways and Means, 108th

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 and

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 specific

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 substantial

     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 corpor-

ation’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 the

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 to

fill the inevitable 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 ambigu-

ity in the Code.     Redlark v. Commissioner, 141 F.3d 936, 939 (9th

Cir. 1998), revg. 106 T.C. 31 (1996); Swallows Holding, Ltd. v.

Commissioner, 126 T.C. 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 ex-

plained above, the regulation is a perfectly reasonable construc-

tion of that term.    If, as also explained above, a custodial ac-

count is not a person, but a way a person can own property, then

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 evi-

dence 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 doctrine

* * * is most useful in situations where there is some indication

that Congress noted or considered the regulations in 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, 302-03 (6th Cir. 1991), revg. T.C.

Memo. 1990-129.

                                III.

     But there remain two questions that seem to really trouble

the majority:   Why is it only now that anyone is making this

argument?   And wouldn’t the system fall apart if people could

hold S corporation shares in their IRAs?

                                 A.

     Whenever a novel legal argument about an old law is pro-

posed, a prudent judge should ask why no one’s ever thought of it

before.   But whatever presumption of incorrectness novelty must

bear, it can’t be a complete bar.26

     26
        “Two University of Chicago Nobel laureates walking down
a campus sidewalk. One says to the other, ‘There’s a $20-bill on
the sidewalk in front of you.’ Without looking down, the other
laureate retorts, ‘No there isn’t.’ To which the first laureate
says in some frustration, ‘Well, look down. It’s right 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
Business, Univ. of Cal., Irvine (under development in 2008) (but
based on a long oral tradition). On the hazards of picking up
money from sidewalks, see generally Roberts v. State, 12 P.2d 701
                                                   (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 estates27

     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 shareholders28

     1974--Traditional IRAs put in the Code29
     1976--Grantor trusts allowed to be S-corporation
     shareholders30

     1992--Revenue Ruling 92-73 holds that an IRA held by a
     trust is not a trust eligible to be an S-corporation
     shareholder31

     1995--Section 1.1361-1(e)(1), Income Tax Regs., is issued.32

     26
      (...continued)
(Okla. Crim. App. 1931); Atkinson v. Birmingham, 116 A. 205 (R.I.
1922).
      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 65-90, 1965-1 C.B. 428, and 66-266,
1966-2 C.B. 356.
      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 corporations33

     1997--Roth IRAs are put in the Code34

     2004 -- IRAs already owning shares in banks converting to S
     corporation status are expressly made eligible
     shareholders.35

     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 of

eligible S-corporation shareholders, and instead set up a general

principle for dealing with a class of situations where various




     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 partner-
ship 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-corpora-
tion stock will be treated as the shareholder. T.D. 8600, 1995-2
C.B. at 136 (July 21, 1995). His explanation for including par-
tnerships 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 distribu-
tions, see Halpern, J. concurring op. note 1, 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, sec.
302(a), 111 Stat. 825.
      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, supra par. 3.03[9]; Blau et al., 1 S Corpora-

tions Federal Taxation par. 3.30 (2009).    One can understand this

caution--having even one ineligible shareholder triggers revo-

cation of S-corporation status, sec. 1361(b)(1), with its immedi-

ate imposition of a second layer of taxation on profit distribu-

tions to the shareholders.   This makes the absence of precedent

on the question understandable--for a corporation that has share-

holders who have put their stock in an IRA, electing S-Corpora-

tion status could 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-corpora-

tion 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 bene-

fit to a Roth IRA-owned business compared to a C corporation

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 li-

mitations on what can go in and out of an IRA--income-contribu-

tion limits, sec. 219; deadlines for contributions, sec. 219;

penalties on prohibited transactions, sec. 4975; penalties on ex-

cess 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 to imposition 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 re-

ceived nearly a million dollars in unreported taxable dividends

from the operating business standing in back of Taproot that

flowed into his custodial account.     It really would be tax alche-

my 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 summary-

judgment 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 re-

braided 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 and

applied the regulation as it is.

     I respectfully dissent.

     FOLEY, KROUPA, and MORRISON, JJ., agree with this dissenting
opinion.
