Taxpayers recently got some good news via the 6th Circuit Court, and most have no idea. The court recently ruled in favor of a Roth IRA owner who “fed” his account with about $5 million in business directed the account’s way by the owner. This means that account owner will never pay income taxes on that $5 million or the income that it generates in the future.
Here’s the simplified version of what happened:
“Mr. Beneson” owned a company called Summa Holdings. He established a small Roth IRA and made about $7,000 total in contributions to that account before forming a special type of C-Corporation called a DISC, naming it JC Export 1, and selling shares of that DISC to his Roth IRA for about $3,500. DISCs get special tax breaks when they export goods and are valuable assets to hold.
Mr. Beneson then used JC Export 1’s services, paid it commissions, and took hefty tax deductions on those commissions, while JC Export 1’s special tax breaks ultimately meant that the transfer of commissions from Mr. Beneson’s company, Summa, to JC Export 1 were essentially tax-free. JC Export 1 then distributed any remaining cash to Mr. Beneson’s Roth IRA, which owned its shares.
Not surprisingly, the IRS decided to audit Mr. Beneson and his assorted entities. Also not surprisingly, Mr. Beneson lost his case in Tax Court. What is surprising is that when he appealed in the 6th Circuit Court, he won. The court ruled that the entire transaction was legitimate under current law and that Beneson could keep his business structures (and his tax-free $5 million) intact.
N.B. The case was a bit more complicated than I have described it here, and I’m not offering any legal advice in this article, only education.
So what does this mean for Beneson and other Roth IRA account holders?
- Beneson’s $5 million remains tax-free and inheritable
At this point in time, another account holder doing the same thing could also reap these rewards. However, the court made an important point in its decision: although the IRS could not sue Beneson under existing law, the IRS can petition Congress to change the law. If Congress does so, then future outcomes could be different. So don’t start counting your chickens just yet. - Sometimes courts will rule in your favor if your Roth IRA transaction is “gray,” and that makes a case against you less appealing
In my experience, many IRS attorneys will avoid taking “gray” cases to court if they do not believe that they can decisively prove that the taxpayer crossed a line. Gray cases tend to get settled, often in the taxpayer’s favor, and can take the “edge” off IRS strategies for collecting revenues, fines, and penalties. - Let’s not get stupid, because the IRS does learn from its mistakes
While they lost this case, their approach was much more sophisticated than a very similar case from 1996 and, furthermore, I think there are some arguments that the IRS missed in this case that could have changed the result. This case is reason for celebration, but also for humility and care, for they shall adapt and improve their approach. We must be ready, anticipate their next evolution, and structure our transactions accordingly.
So, Will the IRS Appeal?
Will the IRS try to take another shot at Mr. Beneson? I don’t think so. Going to the Supreme Court risks the ruling in this case being taken nationwide, whereas the IRS can “live to fight another day” if they allow the ruling to stand, uncontested, in this court and in the very specific instance of Roth IRAs that use DISCs. Privately (for example, when negotiating settlements to other “grey IRA” audits), they will be quite aware that other courts may mimic the Summa decision (especially the more conservative circuits) and will take the Summa decision into account when deciding whether to litigate or settle, and how much they are willing to settle for, and that is good news for taxpayers.
You can read a more detailed write-up of this case by clicking “Articles” on iralawyer.com.
About the Author
John Hyre is an attorney, accountant and real estate investor based out of Columbus, Ohio. He advises clients nationwide on to avoid tax trouble when structuring their self-directed IRA’s, 401(k)’s, HSA’s and CESA’s. John has also successfully defended SDIRA’s from IRS attack in audits and in Tax Court. He can be reached at johnhyre@realestatetaxlaw.com or at www.iralawyer.com.
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