IRS’s application of substance-over-form doctrine | KPMG | US
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Sixth Circuit: IRS’s application of substance-over-form doctrine rejected

IRS’s application of substance-over-form doctrine

The U.S. Court of Appeals for the Sixth Circuit today reversed a decision of the U.S. Tax Court that had upheld a deficiency determination based on application of the “substance-over-form doctrine” by the IRS. The Sixth Circuit found that the IRS had no basis for recharacterizing the transactions at issue because the point of the Code provisions allowing taxpayers to establish domestic international sales corporation (DISC) and Roth IRAs “…is tax avoidance.”


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The case is: Summa Holdings, Inc. v. Commissioner, No. 16-1712 (6th Cir. February 16, 2017). Read the Sixth Circuit’s decision [PDF 101 KB]


The taxpayers used a DISC to transfer money from their family-owned company to their sons’ Roth IRAs. Through a series of transactions, the taxpayers transferred over $5 million from the company to the Roth IRAs. 

In 2012, the IRS issued notices of deficiency to the taxpayers, and informed the taxpayers that the substance-over-form doctrine would be applied to reclassify the payments (even though it was agreed that the taxpayers had complied with the relevant provisions of the Code). The Tax Court upheld the deficiency determination, and this appeal followed.

The Sixth Circuit today reversed, finding that the IRS had no basis for recharacterizing the transactions because the taxpayers had used the DISC and Roth IRA provisions “…for their congressionally sanctioned purposes—tax avoidance.” As the appeals court noted, the Code allows the taxpayers to do what they did. 


It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction—to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes—to ignore their form, their words, in favor of his perception of their substance.


The Sixth Circuit stated that application by the IRS of the substance-over-form doctrine makes sense when the taxpayer’s formal characterization of a transaction fails to capture economic reality, and would distort the meaning of the Code. However, the court concluded that the Code authorizes DISC commissions and dividends (regardless of whether they have economic substance) in order to reduce the tax burden of exports, and authorizes investors to avoid significant taxes on capital gains and dividends by using their Roth IRAs “in all manners of tax-avoiding ways.”

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