Employee Benefits-Sixth Circuit Holds That A Transfer Of Funds From A DISC To Roth IRAs Is Not Taxable

In Summa Holdings, Inc.v. Comm’r, No. 16-1712 (6th Cir. Feb. 16, 2017), the Commissioner of the Internal Revenue Service had denied relief to a set of taxpayers who complied in full with the printed and accessible words of the tax laws.  The Benenson family, to its good fortune, had the time and patience (and money) to understand how a complex set of tax provisions could lower its taxes.  Tax attorneys advised the family to use a congressionally innovated corporation—a “domestic international sales corporation” (DISC) to be exact—to transfer money from their family-owned company (“Summa Holdings”) to their sons’ Roth Individual Retirement Accounts.  When the family did just that, the Commissioner balked.  He acknowledged that the family had complied with the relevant provisions.  And he acknowledged that the purpose of the relevant provisions was to lower taxes.  But he reasoned that the effect of these transactions was to evade the contribution limits on Roth IRAs and applied the “substance-over-form doctrine,” to recharacterize the transactions as dividends from Summa Holdings to the Benensons followed by excess Roth IRA contributions, resulting in tax and penalties. The Tax Court upheld the Commissioner’s determination.

In analyzing the case, the Sixth Circuit Court of Appeals (the “Court”) said that each word of the “substance-over-form doctrine,” at least as the Commissioner has used it here, should give pause.  If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is “substance” when it comes to law.  The words of law (its form) determine content (its substance).  How odd, then, to permit the tax collector to reverse the sequence—to allow him to determine the substance of a law and to make it govern “over” the written form of the law—and to call it a “doctrine” no less.

As it turns out, said the Court, the Commissioner does not have such sweeping authority.  And neither do we.  Because Summa Holdings used the DISC and Roth IRAs for their congressionally sanctioned purposes—tax avoidance—the Commissioner had no basis for recharacterizing the transactions and no basis for recharacterizing the law’s application to them.  Accordingly, the Court reversed the Tax Court, refusing to support the Commissioner’s determination.