Exporters should already be familiar with the IC-DISC (Interest-Charge Domestic International Sales Corporation, often abbreviated to “DISC”). A DISC is a C corporation with a special election in place, and typically exists in form only with minimal substance requirements. An exporter of domestically manufactured property pays a commission expense to a DISC to reduce its taxable income. The DISC, which is not a taxpaying entity, then pays out its earnings as a qualified dividend to its U.S. shareholders. Most DISC structures result in tax savings through the tax rate arbitrage between ordinary income and the qualified dividend rate, or by allowing a C corporation to effectively deduct dividend payments.
The DISC continues to be a valuable tax incentive for exporters following the Tax Cuts and Jobs Act of 2017. However, due to cuts to the corporate tax rate and the new qualified business income deduction for pass-through owners, some DISC structures may be producing decreasing tax savings than provided prior to tax reform. For some taxpayers, a Roth IRA structure using a DISC may present a new and powerful opportunity to maximize the benefits of the DISC following tax reform.
The structure works by using a DISC, which is ultimately owned by one or more Roth IRAs. A related exporter pays deductible commission payments to the DISC, which are then distributed (either directly or indirectly) to the Roth IRA. The DISC distributions are subject to corporate tax before or upon contribution into the Roth IRA (depending on the exact structure), but the taxpayer is effectively able to bypass IRA contribution limits, allowing for exponentially more tax-free retirement portfolio growth than otherwise allowable.
A taxpayer group including the Benenson Family and their closely held exporting company Summa Holdings have spent the last several years defending this structure in the tax courts, ultimately emerging victorious. The IRS ruled, and initially successfully defended, that the substance over form doctrine applies to a Roth IRA-owned DISC structure and commission payments should be recharacterized as excess IRS contributions. However, in decisions spanning three different appellate court circuits (First, Second, and Sixth), the Courts ultimately sided in favor of the taxpayers (see Summa Holdings v. Comm. and Benenson, Jr. v. Comm.). As reasoned in the Sixth Circuit appeals decision, “by congressional design, DISCs are all form and no substance, making it inappropriate to tag (the taxpayers) with a substance-over-form complaint with respect to its use of DISCs.”
Taxpayers in the First Circuit (Maine, Massachusetts, New Hampshire, and Rhode Island), Second Circuit (Connecticut, New York, and Vermont), or Sixth Circuit (Kentucky, Michigan, Ohio, and Tennessee) may have judicial authority to use a Roth IRA structure using their DISC. Taxpayers in those circuits should be aware that listed transaction disclosures may be required when using a Roth IRA corporation structure and taxpayers should consult their tax advisor before implementing.
If you have any questions or would like to discuss further, please contact our team today.
