The Sixth Circuit’s Summa Bomb-shell

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We welcome back guest blogger Stu Bassin. Stu is a solo practitioner in Washington, D.C. who specializes in tax controversy work. Today he talks about Summa Holdings v Commissioner, where the Sixth Circuit disagreed with the IRS and Tax Court’s applying a substance over form analysis. The role of anti-abuse provisions in the tax law is controversial, and Stu discusses how taxpayers, the Service and courts are likely going to wrestle with these concepts when IRS challenges transactions that may technically satisfy statutory requirements but seem to be inconsistent with broader tax principles. Les

 The Sixth Circuit issued a remarkable opinion last week, giving the taxpayer a full victory in what the Service tried to characterize as a tax shelter. The decision in Summa Holdings v. Commissioner, No. 16-1712 (6th Cir. February 16, 2017), reversed a Tax Court ruling in favor of the Service and represents the most decisive and significant appellate victory for a taxpayer in the area of judicial doctrines in over a decade.


The Summa case arose out of a clever strategy in which a closely-held corporation employed a Domestic International Sales Corporation (“DISC”) and a Roth IRA to transfer corporate profits into its shareholders’ hands with a minimal tax bite. To briefly summarize, the statutory regime governing DISCs allows companies to defer income on the portion of the DISC’s which is distributed to the DISC’s shareholders as a dividend. The DISC’s shareholders receive the dividend without paying a corporate level tax. The novel twist in Summa was that the DISC’s shareholder was a Roth IRA—an entity which does not pay taxes on its earnings. Thus, neither the DISC nor the taxpayer would pay tax on the remainder of the dividend or on future earnings within the Roth IRA, although the taxpayer would pay an unrelated business income tax on a portion of the dividend received.

Upon audit, the Service recognized that the taxpayer’s strategy satisfied all of the statutory requirements for the treatment it sought under the DISC and Roth IRA statutory provisions. Nonetheless, the Service determined that the “substance over form” doctrine applied and that the payments would not be treated as DISC dividends, but would instead be treated as dividends from the parent company to the shareholders—a recharacterization which substantially increased the shareholders’ tax liability. To add insult to injury, the Service also added a substantial understatement penalty. The Tax Court upheld the Service’s determinations and the taxpayer appealed. In the Summa decision, the Sixth Circuit reversed, ruling that the Service could not apply the substance over form doctrine to the disputed transaction.

The issue, in the court’s view, was whether the Service had crossed the elusive “line between disregarding a too-clever-by-half accounting trick and nullifying a Code-supported tax-minimizing transaction”—the same broad issue which arises in many so-called “tax shelter” cases.  Both sides agreed that, in form, the transactions complied with the text of the Code, but disagreed whether the substance-over-form doctrine could nonetheless be invoked. Rejecting the Service’s position, the court observed that tax law is governed by a highly nuanced set of rules articulated with nearly mathematic precision, particularly in the DISC arena and that “all areas of law that should resist judicial innovation based on misty calls to higher purposes, this would seem to be it.” While endorsing application of judicial doctrines in some cases involving factual shams and transactions which have no legitimate non-tax business purpose, the court concluded that the doctrine “does not give the Commissioner a warrant to search through the  . . . Code and correct whatever oversights Congress happens to make or redo any policy missteps the legislature happens to make.” If Congress found the result improper, it could amend the statutes, but it was not the role of courts to legislate.

Read broadly, the Summa decision is a bomb-shell; it breaks a decade-long string of Service victories in appellate cases which rest upon application of judicial doctrines like the substance-over-form rule to undo transactions which the taxpayer designed to comply with the literal language of the Code (the most recent taxpayer victories were in 2001 in the 5th Circuit Compaq Computer v Commissioner and 8th Circuit in IES Industries v US). In almost all of the cases where the government prevailed, the taxpayer argued that it had complied with the Code and that it was inappropriate to invoke judicial doctrines or to judicially legislate based upon a judge’s gut reactions to particular transactions. While most of the appellate courts have sided with the Service, the opinion of the Sixth Circuit emphatically rejected the Service’s position—complete with an allusion to Caligula.

Where the case goes from here is a great topic for speculation.   The recurring question of the parameters of the judicial doctrines is not going to go away and Summa potentially represents a very important conflict between the circuits. However, presentation of that fundamental issue is probably something the Government will likely try to avoid; a large body of Service-favorable law has developed since the Supreme Court’s last “judicial doctrine” ruling–the 1978 Frank Lyon decision. The vitality of all that law would be in play if Summa were to reach the Supreme Court.

Recognizing the stakes which would be at risk in a Supreme Court ruling on Summa, the Service and the Solicitor General are more likely to dodge the issue by offering a narrow reading of Summa, attempting to confine its reach to cases involving statutory grants of narrow tax benefits to a particular favored category of taxpayers such as DISCs. Indeed, the argument for application of generalized judicial doctrines to avoid tax avoidance is much weaker where Congress has so explicitly granted specific benefits which allow tax avoidance—benefits like those granted to DISCs and applied in Summa. Of course, the Government prevailed in a comparable context in the Third Circuit’s Historic Boardwalk ruling (which involved statutory rehabilitation tax credits), and it would be difficult to reconcile the two cases, but the conflict would be far less significant and is likely a matter which the Government would let stand before it ran the risk of a new Supreme Court decision on the judicial doctrines.


  1. Stu, nice job. Jim Malone.

  2. This post looks at the big picture, jurisprudence, implications of Summa Holdings. How about the direct effects of this tax dodge being legal? How many people can take advantage of it?

    The dodge is complicated enough that I don’t understand it, but I gather it’s something like this. The taxpayer creates a DISC corporation and makes his Roth IRA the only shareholder. Then he puts some assets into the DISC. For example, a corporation could give the DISC 90% of its shares. Each year the DISC distributes all profits as dividends, tax free. The Roth IRA gets those dividends, and when it pays out to the beneficiary when he’s 70, he pays no taxes then either, it being a Roth IRA.

    But if that’s the dodge, why isn’t the initial putting of assets into the DISC an over-the-limit contribution to the Roth IRA in the first place? (or, the gift of DISC shares, if it’s done after the DISC is created)

    Anyways, if the dodge does work, does that mean all closely held corporations will do this? If so, is Congress noticing this and readying a statutory override? If so, I hope they make it retroactive except for Summa Holdings, who ought to get some reward for exposing a loophole.

    • Eric, I don’t think it’s that broad a loophole. From reading the opinion, it will only work for those who can already use DISC’s, that is, have “qualified exports.” The DISC itself doesn’t necessarily have much in the way of value when it’s created and contributed to the Roth IRA. (“The Commissioner did not challenge the valuation of these shares then and has not challenged them since.”) The Roth IRA only gains value as the DISC receives commissions from the exporter. And, as with other income-producing property contributed to IRAs, the contribution is based on the value of the income-producing property when contributed, not the subsequent income earned.

      Summa challenges the common attitude by the IRS and courts to, in effect, say “this is not what the Code intends” with little evidence to that effect.

      • Bob, I think you hit the nail on the head. The key issue is whether a corporation actually conducts export activities. If a corporation technically qualifies and elects as a DISC but does not actually conducted export activities, the court would likely ask, “What are you trying to pull?”

  3. John Strupe says

    At Gomel, Davis and Watson, LLP, we have used this structure for clients with great success. I am glad to see the appellate court has sided with the taxpayer.

  4. The 6th Circuit had the case right on the substance over form. The IRS has admitted in its own TAMs that IC-DISCs override transfer pricing and assignment of income. That said, it’s insane to me to advocate these structures with no DOL opinion (and similar, such as PPLI, or with Roth IRAs owning captives or other closely held companies etc). They are clearly prohibited transactions. The IRS should not use some airy substance over form when they have adequate tools to combat the abuse. I wrote an article to this effect: Summa Holdings Inc. v. Commissioner: 6th Circuit Properly Rejects IRS and Tax Court Substance Over Form Attack on IRAs Owning IC-DISCs, But the IRS Missed the Prohibited Transactions, LISI Employee Benefits & Retirement Planning Newsletter #672

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