In Summa Holdings, Inc. v. Comm’r of Internal Revenue, a unanimous panel reversed the judgment of a United States Tax Court and rejected the Tax Commissioner’s attempt to reclassify a series of transactions which had originally allowed two taxpayers to avoid Roth IRA contribution limits and lower their tax obligations.  The Court recognized that the petitioners’ complicated series of transactions were essentially a strategy for funneling money into Roth IRAs without triggering the contribution limits but that the taxpayers had fully complied with the text of the tax laws in doing so.

The Court summarized that a qualifying corporation may elect to be treated for tax purposes as a domestic international sales corporation (DISC). An exporter may avoid corporate income tax by paying a DISC commissions of up to 4% of the exporter’s gross receipts or 50% of net income from qualified exports.  The DISC pays no tax on the commission (up to $10,000,000).  The DISC may pay dividends to its shareholders and those shareholders may include Roth IRAs.  Roth IRA account holders do not deduct their contributions from pre-tax income, but an account holder may take tax-free withdrawals including on accrued gains.

In this case, a family owned a manufacturing company, Summa Holdings. In 2001, the sons opened Roth IRAs.  Each Roth IRA purchased shares of DISC JC Export.  The family then formed JC Holding, which bought from the IRAs the DISC shares.  JC Holding became the sole shareholder in JC Export, and each IRA was a 50% shareholder in JC Holding.  Summa Holding would pay tax free commissions to JC Export, which in turn would distribute dividends to JC Holding, which were taxed at 33%.  The remaining balance would be distributed as dividends to the Roth IRAs.  As a result, the family was able to transfer to the Roth IRAs from 2002 to 2008 more than $5 million––far in excess of the usual Roth IRA contribution limits.

The Court rejected the Commissioner’s attempt to reclassify the transactions under the substance-over-form doctrine and balked at the Commissioner’s contention that when taxpayers are presented with alternative methods of structuring a transaction, the taxpayer must choose that which results in higher tax liability. The Court noted that Congress created DISCs to encourage companies to export goods by lowering their taxes and that the Commissioner cannot fault taxpayers for taking advantage of tax savings so long as they fully comply with the “printed and accessible words of the tax laws.”