S corporations are small firms with a limited number of shareholders, and are favoured vehicles for protecting the income of small businesses and wealthy celebrities. According to a Reuters report on the issue:

'Because of changes in the tax code, some S corporations could have used their stock ownership plans, or ESOPs, to avoid taxation, by limiting the size of ESOP plans. That move was disallowed by Congress, but it did give those taxpayers using questionable plans until 2005 to change them.'

Accordng to the IRS, however, this provision has been utlised by some S corporation heads and tax promoters to sell the schemes on to other taxpayers as temporary tax shelters, safe from the scrutiny of the tax authority until at least 2005.

On Tuesday, the IRS announced that:

'This revenue ruling alerts taxpayers and their representatives that the tax benefits purportedly generated by these transactions are not allowable for federal income tax purposes. This revenue ruling also alerts taxpayers, their representatives, and organizers or sellers of these transactions to certain responsibilities that may arise from participating in these transactions.'

However, speaking to Reuters earlier this week, Michael Keeling, president of the Washington-based ESOP Association expressed little concern over the ramifications of the IRS ruling, explaining that he knew of only a very few cases in which S corporations had attempted to take advantage of the ESOP loophole.

'This ruling is fine, as far as the ESOP community is concerned,' he told the news service.