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Benenson v. Commissioner of Internal Revenue

United States Court of Appeals, First Circuit

April 6, 2018

CLEMENT C. BENENSON, Petitioner, Appellant,
COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee. JAMES BENENSON III, Petitioner, Appellant,

          APPEALS FROM THE UNITED STATES TAX COURT Hon. Kathleen Kerrigan, U.S. Tax Court Judge

          Neal J. Block, with whom Robert S. Walton and Baker & Mackenzie LLP was on brief, for appellants.

          Ellen Page DelSole, Attorney, Tax Division, U.S. Department of Justice, with whom David A. Hubbert, Acting Assistant Attorney

          General, Tax Division; Gilbert S. Rothenberg and Teresa E. McLaughlin, Attorneys, Tax Division, U.S. Department of Justice, were on brief, for appellee.

          Before Lynch, Stahl, and Thompson, Circuit Judges.


         Clement Benenson ("Clement") and James Benenson III ("James III") appeal from the Tax Court's ruling that they owe an excise tax for contributions made to their Roth individual retirement accounts ("Roth IRAs") in violation of contribution limits. Using the common-law substance over form doctrine, the Commissioner of Internal Revenue recharacterized a transaction Clement and James III entered into to reduce their federal taxes, and the Tax Court affirmed. Summa Holdings, Inc. v. Comm'r, 109 T.C.M. (CCH) 1612 (2015). After careful consideration, we find the transaction violates neither the letter nor purpose of the relevant statutory provisions and therefore reverse the Tax Court's decision.


         Summa Holdings is a C corporation and the parent of a consolidated group of manufacturing companies with export sales.[1] In 2008, Summa Holdings' largest shareholders were James Benenson, Jr. and the James Benenson III and Clement Benenson Trust ("the Trust"). James Benenson, Jr. and his wife Sharen are the trustees of the Trust and Clement and James III are the beneficiaries. This case arises from a transaction the Benensons and Summa Holdings engineered to reduce their federal taxes through the use of domestic international sales corporations ("DISCs") and Roth IRAs.

         Congress created DISCs as a part of the Revenue Act of 1971, Pub. L. No. 92-178, 85 Stat. 497. A company that produces goods for export can contract to pay a DISC a commission from its export sales. The DISC pays no federal corporate income tax on these commissions. 26 U.S.C. § 991.[2]

         Once a DISC receives funds from the commissions, it may, if it chooses, issue dividends to its shareholders. The DISC's shareholders "often will be the same individuals who own the export company." Summa Holdings, Inc. v. Comm'r, 848 F.3d 779, 782 (6th Cir. 2017). Thus, "the net effect of the DISC is to transfer export revenue to the export company's shareholders as a dividend without taxing it first as corporate income." Id.

         Congress created Roth IRAs as a part of the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec. 302, 111 Stat. at 825. Different from the rules governing traditional IRAs, contributions to a Roth IRA are not deductible, 26 U.S.C. § 408A(c)(1), but qualified distributions from the account are not taxed, 26 U.S.C. § 408A(d)(1). Traditional and Roth IRAs are subject to the same annual contribution limits, and in 2008, these limits were set at $5, 000. 26 U.S.C. §§ 219(b)(5)(A), 408A(c)(2). If an IRA of either type exceeds the contribution limits, it is subject to a 6% tax annually on the amount of excess contributions. 26 U.S.C. § 4973(a).

         In 2004, the Internal Revenue Service ("IRS") released Notice 2004-8 ("the Notice"), which described transactions some taxpayers were entering into "to avoid the statutory limits on contributions to a Roth IRA." I.R.S. Notice 2004-8, 2004-1 C.B. 333. The transactions described in the Notice involved a taxpayer who owned a preexisting business, a Roth IRA maintained for the taxpayer's benefit, and a corporation acquired by the Roth IRA. Id. The corporation owned by the Roth IRA would enter into an agreement with the taxpayer's business whereby the business would transfer value to the corporation. Id. The Notice described how either the Roth IRA's purchase of shares in the corporation or the transaction between the taxpayer's business and the corporation would not be "fairly valued" and would therefore have "the effect of shifting value into the Roth IRA" in excess of the contribution limits. Id. The Notice declared that the IRS intended to deny or reduce deductions made using these transactions. Id.

         On January 30, 2002, James III and Clement each deposited $3, 500 into individual Roth IRAs they had established a few weeks earlier. On January 31, 2002, each of the Roth IRAs paid $1, 500 for 1, 500 shares in JC Export, a newly formed DISC. That same day, the Roth IRAs sold their shares in JC Export to JC Export Holding ("JC Holding"), a C corporation the Benensons also formed that day. Each of the Roth IRAs received a 50% stake in JC Holding. The parties agree that JC Holding:

was formed, in part, so that the Roth IRAs would not have unrelated business income and the associated tax reporting obligations and, in part, so that the custodians of the Roth IRAs no longer would be involved as shareholders of JC Export and, thus, would avoid being required to take shareholder actions regarding JC Export.

         JC Export entered into agreements with Summa Holdings' subsidiaries to receive DISC commissions. Once JC Export received payments from Summa Holdings' subsidiaries, it immediately transferred the funds to JC Holding. After setting aside the amount it estimated it would owe in federal income taxes, JC Holding immediately paid out the remainder of the funds to the Roth IRAs as a dividend. In 2008, JC Holding transferred $1, 477, 028 to the Roth IRAs. By the end of 2008, the James III Roth IRA was worth $3, 145, 086 and the Clement Roth IRA was worth $3, 135, 236.

         James III and Clement have stipulated that the "sole reason for entering into the Transaction at Issue . . . was to transfer money into the Roth IRAs so that income on assets in the Roth IRAs could accumulate and be distributed on a tax-free basis." They likewise stipulated that they had no non-tax business purpose for establishing the Roth IRAs, JC Export, and JC Holding.

         In 2012, the Commissioner issued a notice of deficiency for the 2008 tax year to Summa Holdings, the Trust, and James III and Clement. The Commissioner determined that the DISC commissions paid to JC Export were not, in substance, DISC commissions; they were in fact dividends to Summa Holdings' shareholders. The Commissioner viewed the resulting payments from JC Holding to the Roth IRAs not as dividends, but as contributions to the Roth IRAs in excess of the contribution limits.

         The Tax Court affirmed the Commissioner's determination. Summa Holdings, Inc. v. Comm'r, 109 T.C.M. (CCH) 1612 (2015). The Tax Court found it was appropriate for the Commissioner to recharacterize the transaction under the substance over form doctrine because the transaction's sole purpose was to "shift[] millions of dollars into Roth IRAs in violation of the statutory contribution limits." Id. at *20.

         Summa Holdings appealed to the Sixth Circuit, which reversed the Tax Court's decision. Summa Holdings, 848 F.3d at 782. The Sixth Circuit found the Commissioner "had no basis for recharacterizing the transactions" because the taxpayers had "used the DISC and Roth IRAs for their congressionally sanctioned purposes -- tax avoidance." Id.

         As Massachusetts residents, James III and Clement appeal the Tax Court's decision to this court. James Jr. and Sharen's appeal is pending before the Second Circuit.


         Before discussing the merits of their appeal, the Benensons contend that the Sixth Circuit's ruling in Summa Holdings prevents us from making an independent determination of the issues in this case, invoking the principles of claim preclusion, issue preclusion, and comity. We find otherwise.

         A. Claim Preclusion

         "[T]he essential elements of claim preclusion are (1) a final judgment on the merits in an earlier action; (2) an identity of the cause of action in both the earlier and later suits; and (3) an identity of parties or privies in the two suits." Kale v. Combined Ins. Co. of Am., 924 F.2d 1161, 1165 (1st Cir. 1991) (citations omitted). The Sixth Circuit's decision was a final judgment on the merits, but the second requirement for claim preclusion is missing.

         Each tax year is a different cause of action even when the transaction being disputed and taxpayer is the same. Comm'r v. Sunnen, 333 U.S. 591, 598 (1948). Different tax liabilities owed by different taxpayers present different causes of action, even where the liabilities arise from the same transaction. See Batchelor-Robjohns v. United States, 788 F.3d 1280, 1286-91 (11th Cir. 2015). Here, claim preclusion does not apply because we are determining whether James III and Clement owe excise tax liabilities for the year 2008, not whether Summa Holdings owes a corporate tax liability for that year.

         B. Issue Preclusion

         James III and Clement argue that because the Sixth Circuit decided that the DISC commission was a deductible expense, that there was no constructive dividend, and that there were no excess contributions to their Roth IRAs, the Commissioner is precluded from relitigating these issues in this court. As discussed above, the parties here are different from the parties in Summa Holdings. Generally, offensive issue preclusion cannot apply against the government unless the parties to the litigation are the same. United States v. Mendoza, 464 U.S. 154, 162-63 (1984); United States v. Plat 20, Lot 17, 960 F.2d 200, 211 (1st Cir. 1992). James III and Clement claim they are in privity with Summa Holdings and seek to introduce evidence regarding a 2012 share transfer whereby James III and Clement became the controlling shareholders of Summa Holdings. Because the 2012 transfer was not submitted to the Tax Court, we will not consider it. Based on the record established below, James III and Clement cannot show that they are in privity with Summa Holdings.

         C. Comity

         Finally, comity does not force us to follow the Sixth Circuit. "Comity is not a rule of law, but one of practice, convenience, and expediency." Mast, Foos & Co. v. Stover Mfg. Co., 177 U.S. 485, 488 (1900). A circuit need not follow other circuits' decisions where "there appear cogent reasons for rejecting them." Popov v. Comm'r, 246 F.3d 1190, 1195 (9th Cir. 2001) (quoting Unger v. Comm'r, 936 F.2d 1316, 1320 (D.C. Cir. 1991)). Of course, we will give the Sixth Circuit's decision "the same respectful consideration that we would always accord to sister circuits faced with an identical or similar case." Kanter v. Comm'r, 590 F.3d 410, 420 (7th Cir. 2009).


         We review the Tax Court's decision "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." I.R.C. § 7482(a)(1). We review the Tax Court's legal interpretations de novo. Capital Video Corp. v. Comm'r, 311 F.3d 458, 463 (1st Cir. 2002). "The general characterization of a transaction for tax purposes is a question of law subject to review." Santander Holdings USA, Inc. v. United States, 844 F.3d 15, 23 (1st Cir. 2016) (quoting Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16 (1978)).

         The federal tax system "is, and always has been, based on statute." Id. at 21. "[L]ike other common law tax doctrines, " the substance over form doctrine[3] "can thus perhaps best be thought of as a tool of statutory interpretation." Id. Viewed in this manner, the substance over form doctrine does not "tak[e] a transaction entirely outside its statutory framework, " but instead "helps courts read tax statutes in a way that makes their technical language conform more precisely with Congressional intent." Dewees v. Comm'r, 870 F.2d 21, 35 (1st Cir. 1989) (Breyer, J.).

         Under the substance over form doctrine, the taxpayer's transaction "must be viewed as a whole, " Comm'r v.Court Holding Co., 324 U.S. 331, 334 (1945), to determine whether "the transaction upon its face lies outside the plain intent of the statute." Gregory v.Helvering, 293 U.S. 465, 470 (1937). In this way, we "look[] to the objective economic realities of a transaction rather than to the particular form the parties employed." Frank Lyon Co., 435 U.S. at 573. Courts use the substance over form doctrine when a more wooden application of the Code would "deprive the statutory provision in question of all serious purpose" and would thereby "exalt artifice above reality." Gregory, 293 ...

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