Prior to 2018, the Code generally prohibited nonresident aliens from being shareholders of S Corporations. The IRS explained that the reason was the highly technical loss-tracking, debt considerations, basis calculation, and several other unique aspects of S Corporations that made it impossible for nonresidents to be shareholders since they are not net-basis taxpayers. Although that could be easily avoided with a net-basis election for reporting purposes on Schedule E similar to the Section 871(d) Election for rental income for nonresidents, such an argument was largely considered to be a policy argument. However, with regard to residents from treaty countries, the Nondiscrimination Article arguably impliedly provides for such an election.
Treaty-Based Legal Position
It has long been the legal position of Castro & Co. that the Nondiscrimination Article in every U.S. income tax treaty arguably provides a de facto net-basis election in order to comply with S corporation rules and regulations. And we’re not alone. As the American Bar Association has expressed, the “restriction on S corporation stock ownership by nonresident aliens arguably falls within the scope of the non-discrimination provision.” Other law firms can reasonably disagree with our law firm on this legal position, but to disagree with the American Bar Association without exploring the issue further is bordering on malpractice. It has long been debated and discussed in the international tax community whether denying a resident of a treaty country the right to be a shareholder of an S corporation violates the nondiscrimination provision dating back to 1987.
It is the legal position of Castro & co. that the Nondiscrimination Article in every U.S. income tax treaty legally prevents the IRS from challenging the S Corp status of the entity. Nevertheless, this position of our firm is now largely irrelevant given the recent tax law changes.
New Tax Law Changes Now Make It Permissible
The Tax Cuts and Jobs Act of 2017 amended Section 1361(c)(2)(B)(v) to add a single sentence: “This clause shall not apply for purposes of subsection (b)(1)(C),” which is the prohibition against nonresident alien shareholders. The clause it modified was one that provided a look-through approach for an Electing Small Business Trust (ESBT). In other words, under prior law, a nonresident alien could not be a beneficiary of an ESBT. This modification now means a nonresident can be a beneficiary of an ESBT and, thus, an indirect shareholder of the S Corporation.
Therefore, nonresident aliens can now be S Corporation shareholders via an ESBT.
 See IRC § 1361(b)(1)(C); Treas. Reg. 1.1361-1(g)(1)(i) (citing to IRC § 7701(b)(1)(B)).
 See, e.g., U.S.-United Kingdom Income Tax Treaty, Article 25(4) (2001) (“Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first mentioned Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first mentioned States are or may be subjected.”).
 See “Denial of S Corporation Status to Corporations with Treaty Country Shareholders: Nondiscrimination Concerns,” Tax Mgmt. Mem. 28-23 at 283 (Nov. 9, 1987).
 See Proposals to Amend Subchapter S of the Internal Revenue Code, American Bar Association, Tax Section, S Corporation Committee, (2011) (https://www.americanbar.org/content/dam/aba/events/taxation/taxiq-fall11-truskowski-scorp-paper.authcheckdam.pdf).
 See “Langer Points Out Loophole in Treatment of S Corporations’ Nonresident Alien Shareholders,” 34 Tax Notes 1056 (1987).