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Court Affirms Legality Of Roth IRA DISC Strategy

Here’s another article from written by Adam Bergman –

On February 16, 2017, the United States Appeals Court for the Sixth Circuit in Summa Holdings, Inc. v. Commissioner of Internal Revenue held that using DISC and Roth IRA strategy for their Congressional-sanctioned purpose, tax avoidance, was permissible.  The Appeals Court reversed a previous Tax Court ruling (Summa Holdings Inc. v. Commissioner, T.C. Memo 2015-119) that disallowed a domestic international sales corporation (DISC) Roth IRA strategy on the grounds that it had no non-tax business purpose.

The Summa case is important for taxpayers because it confirms that commissions paid to DISCs owned by IRAs, paid pursuant to the terms of Internal Revenue Code (“Code”), and the subsequent dividends from the DISCs to the IRA, are legal and not subject to attack under the substance over form doctrine.

Summa Holdings is controlled and largely owned by the Benenson family, including two sons. The Cleveland-based company is the parent corporation of a group of companies that manufacture industrial products that are sometimes exported. To encourage exports for closely held United States companies like Summa that lack any meaningful foreign presence, Congress, in 1971, authorized the use of a DISC. The tax break is that the parent firm doesn’t owe corporate-level income tax on “commissions” paid to the DISC on its qualified exports. Properly structured, a DISC has no activities other than on paper and no activities not related to the export of qualifying goods.

In Summa, much like the facts in Swanson v. Commissioner (106 T.C. 76 (1996), a well-know case on the legality of the checkbook control self-directed IRA structure, the owner of a closely held export company would transfer money from the company (Summa Holdings) to the DISC (JC Export), as the statute encourages, and pay some (or all) of that money as a dividend to its shareholders (JC Holding, which was wholly owned by the Roth IRAs), allowing the money to enter the Roth IRA and grow there tax-free. The IRA account holder would have to pay the high unrelated business income tax—here roughly 39%—when the DISC dividends go into the IRA. But once the Roth IRA receives the money, the account holder could invest the remaining Roth IRA funds freely without having to pay any further taxes.  From 2002 to 2008, the Benensons transferred $5,182,314 from Summa Holdings to the Roth IRAs in this way, including $1,477,028 in 2008. By 2008, each Roth IRA had accumulated over $3 million.

The IRS was concerned that there was no non-tax business purpose or economic purpose for establishing the DISC and felt that using the Roth IRA as the DISC owner had no economic substance and was a sham solely done for tax purposes. The IRS felt strongly that the tax benefits enjoyed by SUMMA were unintended by both the Roth IRA and DISC provisions.

However, the Sixth circuit Appeals Court held that the tax code allowed the Benensons to use the Roth IRA owned DISC strategy. Internal Revenue Code Section 995(g) expressly contemplates that tax-exempt entities like traditional IRAs may own DISC shares. It just requires that they pay unrelated business income tax on any dividends. The Benensons paid those taxes. The Appeals Court further held that the DISC Roth strategy was not a sham and did not defy economic substance.  The Court confirmed that structuring a transaction to minimize taxes is not enough to label the transaction as a sham or lacking economic substance.

In the words of the Court: “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 collectors is. The Court indicated that if Congress sees DISC–Roth IRA transactions as unwise of lacking economic substance, it should fix the problem. The IRS attempted to fix the problem by having Congress impose the unrelated business income tax on their DISC dividends, but it would be up to Congress to wholly eliminate the strategy.

At this time it is unclear whether the IRS or Department of Justice will appeal.  However, what is clear is that the Appeal Courts decision could help many exporters devise a tax friendly strategy for shifting taxable commission income to a Roth IRA.

For more information about the Roth IRA DISC strategy, please contact us @ 800.472.0646.

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