Following up on last week's post, Sixth Circuit Reverses IRS, Tax Court: 'Citizens Can't Comply With Tax Laws They Can’t See': Wall Street Journal Tax Report, The Secret to Avoiding Taxes on $6 Million: Exports and an IRA:
In less than a decade, two brothers turned a $3,000 investment into $6 million. Thanks to a federal appeals court, they won’t owe income taxes on this monster return.
To lower their taxes, the brothers paired a common retirement account with an obscure export incentive. The Internal Revenue Service challenged these moves in court, arguing that even if the transactions didn’t break the letter of tax law, they violated the spirit of it.
But the transactions were upheld by the U.S. Sixth Circuit Court of Appeals. The decision, Summa Holdings Inc. v. Commissioner, provides new ballast for taxpayers who use legal techniques in ways the Internal Revenue Service objects to.
“It says that if there are two ways to structure a transaction and one incurs less tax, then the IRS can’t force the taxpayer into the other one,” says Robert Willens, an independent tax expert based in New York. ...
[T]he Benenson brothers were able to transfer $5.2 million from Summa Holdings to their Roth IRAs from 2002 through 2008 in this way. By 2008, each Roth IRA had more than $3 million in it.
The IRS objected. It argued that the transactions improperly circumvented the Roth IRA rules because the brothers’ high income precluded a contribution and that the annual contribution was only a few thousand dollars at the time. Therefore, Summa owed income tax on the DISC commissions and the brothers owed penalties for overfunding their Roth IRAs.
The Tax Court sided with the IRS, but the Sixth Circuit appeals court reversed the decision. It reasoned that lawmakers awarded tax breaks to DISCs and Roth IRAs to promote certain activities, so “the Commissioner cannot fault taxpayers for making the most of the tax-minimizing opportunities Congress created.”
This decision will benefit many exporters, large and small, who use Roth IRAs for DISC commissions or would like to. But its impact is likely to go far beyond the DISC area, says Mr. Willens, because it “puts a damper on what the court saw as IRS overreaching.”