United States

Sixth Circuit ruling sets boundaries to substance-over-form doctrine


In Summa Holdings Inc. v. Commissioner, the Sixth Circuit Court of Appeals recently ruled against the IRS and allowed a taxpayer to own a Domestic International Sales Corporation (DISC) through a Roth IRA. The decision overruled the Tax Court, which had found such a tax advantaged structure improper. At its core, the Circuit Court’s opinion addressed the IRS’s application of the substance-over-form doctrine.

The substance-over-form doctrine dates back to 1935 and the U.S. Supreme Court ruling in Gregory v. Helvering. Generally the doctrine states the tax consequences of a transaction depend upon the substance, rather than the form of the transaction. Where applicable, courts may look to the underlying economic reality of a transaction when determining the proper tax treatment.

The IRS argued, and previously the Tax Court had agreed, that while both the DISC and the Roth IRA were enacted for the purpose of providing tax benefits to their owners and beneficiaries, the taxpayers used these provisions to improperlly sidestep the Roth IRA contribution limitations. The IRS claimed this ran against the congressional intent, and the Tax Court had ruled that the transaction should be re-characterized to reflect its substance, that of an excess Roth IRA contribution, rather than its form, that of a DISC dividend to a Roth IRA.

In reversing the Tax Court, the Circuit Court concluded that the application of the substance-over-form doctrine to this case was inappropriate. The Circuit Court noted that Congress intended both the DISC and the Roth IRA to serve as tax reduction tools and in the present case the taxpayers complied in full with the written laws governing each. As such, the court determined it would be inaccurate to re-characterize the transaction under the substance-over-form doctrine. The court also acknowledged that the structure used by the taxpayers allowed for Roth IRA balances in excess of what contribution limits otherwise might allow, but they concluded that its economic substance, nonetheless, was in line with its form, and its form was allowed in the law.

It is important to note that Roth IRA ownership of a DISC may continue to be challenged by the IRS. However, the IRS’s position appears to be weakening and similar cases currently pending in other circuits may provide additional authority for taxpayers to take this tax advantaged position. Furthermore, this decision could have broader implications as it signals the general narrowing scope of the substance-over-form doctrine. 

Kyle Brown

Senior Manager

Kyle provides tax consulting and compliance services to middle market firms. Contact Kyle at kyle.brown@rsmus.com

Areas of focus: Federal Tax ConsultingTax Planning

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