First Circuit Allows DISC Dividends Paid to Roth IRAs

By Pirrone, Maria M. | Journal of Accountancy, July 2018 | Go to article overview

First Circuit Allows DISC Dividends Paid to Roth IRAs


Pirrone, Maria M., Journal of Accountancy


The IRS suffers its second defeat when the First Circuit, agreeing with the Sixth Circuit, denies application of the substance-over-form doctrine to recharacterize DISC commissions and dividends as excess Roth contributions.

The First Circuit reversed the Tax Court, holding that the IRS did not have the authority to call a transaction a violation of the Code when the transaction did not violate the plain intent of the relevant statutes.

Facts: In 2001James Benenson III and Clement Benenson each established a Roth IRA. Shortly thereafter, each Roth IRA invested $1,500 in JC Export, a newly formed domestic international sales corporation (DISC). The Roth IRAs then sold their JC Export shares to JC Holding, a C corporation the Benensons formed. The Benensons' family-owned business, Summa Holdings, paid DISC commissions to JC Export, which distributed the money as a dividend to JC Holding, which paid income tax on the dividends and distributed the balance to the Roth IRAs.

In 2012, the IRS issued notices of deficiency to Summa and its shareholders --the Benensons and a family trust --for the 2008 tax year. Although it admitted that the transactions complied with the relevant provisions of the Code, the IRS applied the substance-over-form doctrine to reclassify the commission payments from Summa Holdings to JC Export as dividends to the shareholders that they had contributed to the Roth IRAs. In this view of the transaction, the shareholders had contributed more than $1.4 million to the Roth IRAs in 2008, when neither taxpayer was eligible to make any contributions due to the Roth IRA contribution limits.

The Benensons, their trust, and Summa Holdings challenged the IRS's determination in Tax Court. The court agreed with the IRS that Summa's use of the DISC to transfer funds to the Roth IRAs was an attempt to evade contribution limits on the IRAs that did not have a business or economic purpose (Summa Holdings, Inc., T.C. Memo. 2015-119).

Summa Holdings appealed to the Sixth Circuit, which reversed the Tax Court's decision in Summa Holdings, Inc., 848 F.3d 782 (6th Cir. 2017) (see "Tax Matters: Sixth Circuit Upholds DISC Dividends Paid to Roth IRAs," JofA, May 2017, tinyurl.com/y75533n1). As Massachusetts residents, the Benensons appealed the Tax Court's decision to the First Circuit.

Issues: The substance-over-form doctrine often is invoked by courts when taxpayers construct transactions with the goal of tax minimization. Under the doctrine as traditionally applied, where the taxpayer's characterization of a transaction fails to capture economic reality and would distort the meaning of the Code, the IRS may recharacterize the transaction to reflect its economic substance. Transactions undertaken purely for tax purposes that have no independent business purpose are generally held to be subject to recharacterization under the doctrine. …

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