The U.S. Tax Court decided an interesting case involving a Roth IRA last week. In effect, the Court’s decision meant that the IRS couldn’t have its cake and eat it, too.
In Ohsman v. Commissioner of Internal Revenue, the taxpayer had established two separate corporations. The first corporation was a C corporation (Ohsman) in which the taxpayer owned 100% of the stock. Ohsman was engaged in the hide trading business.
The second corporation (Ohsman Export) was a foreign sales corporation. The taxpayer established a Roth IRA, which subscribed to all the previously unissued stock of Ohsman Export.
Over the course of 3 years, Ohsman paid commissions to Ohsman Export amounts in excess of $6.7 million. Ohsman Export made distributions to the taxpayer’s Roth IRA in 2 of the years in question in excess of $1.4 million.
The IRS sought to impose the excise tax under Section 4973 of the Internal Revenue Code on the distributions by Ohsman Export to the taxpayer’s Roth IRA, claiming that these distributions were in reality excess contributions by the taxpayer to his Roth IRA. The IRS also sought to impose additions to tax under Section 6651(a)(1), based on the fact that the taxpayer had not filed Forms 5329, which are returns required when excess contributions to qualified plans are made.
On the taxpayer’s motion for a summary judgment, the U.S. Tax Court held that the taxpayer was, indeed, entitled to a summary judgment in his favor.
The Court said that the IRS could not succeed in its attempt to recharacterize the transaction involving the payments of commissions by Ohsman to Ohsman Export and the distribution by Ohsman Export to the taxpayer’s Roth IRA as a distribution by Ohsman to the taxpayer with a subsequent contribution by the taxpayer to his Roth IRA.
What was the rationale that the Court used to find in favor of the taxpayer? It was simply this–the IRS had to be consistent in its position. The IRS could not invoke the venerable “substance over form” doctrine in this case without making a corresponding income tax adjustment. Since the IRS did not attack the income tax treatment of Ohsman Export’s reporting of the commission income it received from Ohsman (and from which it made the distributions to the Roth IRA) and paying taxes on that commission income, the IRS could not claim that the distributions to the taxpayer’s Roth IRA were excess contributions.
Since the Court determined that the taxpayer was not liable for the Section 4973 excise tax on excess contributions to his Roth IRA, the Court also held that the IRS’s attempt to impose additions to tax under Section 6651(a)(1) for failure to file Form 5329 was also in error.
The net result in the Ohsman case? The taxpayer’s Roth IRA was able to have over $1.4 million added to it in the course of 2 years. In addition, the Court reminded the IRS that it cannot have it both ways–it must be consistent in its position if it wants to invoke the “substance over form” doctrine.