By: Steven A. Loeb
It is undeniable that there are big changes afoot in Washington for 2017. In a United States Court of Appeals, 6th Circuit Opinion, Summa Holdings, Inc. v. Commissioner, No. 16-1712 (2/16/2017), the 6th Circuit held that a taxpayer could combine two legally permissible tax structures: the Roth IRA and the interest-charge domestic international sales corporation (IC-DISC). The Court of Appeals for the Sixth Circuit reversed the United States Tax Court and held that a taxpayer could use an IC-DISC to transfer amounts from a C Corporation to Roth IRAs established by the sons of the C Corporation’s controlling shareholder, and each Roth-IRA exceeded $3 million over a short period of time despite the applicable contribution limits and Roth eligibility requirements. The United States Court of Appeals for the Sixth Circuit stated that taxpayers’ actions were “congressionally sanctioned” and authorized the structure.
Contributions to Roth-IRAs are not tax deductible, but all earnings accumulate tax-free. There is a maximum amount that a taxpayer can contribute to his or her Roth IRA in a tax year. Companies that “export property” and earn a profit are good candidates for the IC-DISC because it reduces their tax liability. Under an IC-DISC strategy, the exporter pays commissions to the IC-DISC. The IC-DISC provides a mechanism for deferral of a portion of the federal income tax on income from exports. The IC-DISC itself is not taxed but instead the IC-DISC’s shareholders are currently taxed on a portion of its earnings. The commissions are deductible to the exporter, and the deemed or actual dividend payment of the commission income in the IC-DISC is taxed to the exporter’s shareholders or partners at a favorable 20% rate. Therefore, on one hand, the exporter receives a deduction of 35% on the commission payments made to the IC-DISC, and on the other hand, only pays a 20% tax rate on the income repatriated from the IC-DISC. This results in a permanent tax savings for U.S. exporters and their shareholders of 10% or higher of net export income.
The pure essence of the IC-DISC is that it reduces its shareholder’s income tax liability by converting ordinary income from sales to foreign unrelated parties into dividend income. An IC-DISC must have its own corporate formality separate and distinct from its related manufacturer, exporter or reseller.
There are many other technical rules that must be followed in order to property structure an IC-DISC. However, what makes them more favorable for some will be to permit Roth IRA’s to own IC-DISC’s and obtain greater tax deferral. These structures need to be carefully planned and one should consult with their tax attorney prior to implementing any such strategy.
For more information please contact via email Steven A. Loeb, Esq. or by phone at 973-538-4700 ext. 229.
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