9th Circuit OKs Roth IRA corporate tax scheme

Reversing a decision by the U.S. Tax Court, a 9th U.S. Circuit Court of Appeals panel ruled Wednesday that the structure of a Congress-authorized corporation can avoid taxes by distributing dividends via Roth IRAs.

The decision is the latest in a series of rulings by circuit courts around the nation against the IRS in its challenges to the structure of corporations that made foreign sales and took advantage of tax breaks.

The victor is a family-owned company in Bakersfield, Mazzei Injector Co., that took advantage of two elements of the tax code, a law creating Foreign Sales Corporations, or FSCs, and another law creating Roth IRAs.

Congress first authorized the Foreign Sales Corporation in 1984 to boost small U.S. companies that sold its products overseas. The statute was replaced with a different law after the World Trade Organization ruled it was an impermissible trade subsidy.

In the meantime, company owner Angelo L. Mazzei, his wife and daughter had used the statute to create a shell corporation that paid modest taxes but returned the remaining income from his business as dividends in the family's Roth IRA accounts, according to the opinion.

The end result was $533,057 in dividends to the Mazzeis' Roth IRAs between 1998 and 2002, money that Carlos Mazzei and his wife and daughter could eventually withdraw tax-free, 9th Circuit Judge Daniel P. Collins wrote.

The IRS, regarding the arrangement as too good to be true, served notices of deficiency against all of the Mazzeis, alleging more than $139,000 in deficient taxes and penalties.

The Tax Court, in a split decision, ruled against the Mazzeis.

But Collins, an appointee of President Donald Trump who wrote for the panel, ruled the Mazzeis' tax maneuver was specifically authorized by Congress. Mazzei et al. v. Commission of Internal Revenue, 2021 DJDAR 5326 (9th Cir., filed Sept. 5, 2018).

"Congress could have taken similar steps either to impose a tax on dividends received by tax-exempt entities from a FSC or to prohibit FSC ownership by such entities altogether, but Congress must be deemed to have chosen not to do so," he wrote.

Collins pointed out that the FSC statute was modeled after an earlier law applying Roth IRA indirect ownership of domestic international sales corporations, or DISCs. The favorable tax treatment of those entities were backed by the 1st, 2nd and 6th U.S. Circuit Court of Appeals.

Judith A. Hadley, an attorney with the U.S. Department of Justice's tax division who argued the case, could not be reached for comment Wednesday.

During oral arguments last year, Hadley focused on criticism in Congress of the tax treatment of such entities.

"In this case, it's about enforcing the tax code's limitations on annual contributions to the Roth IRA," Hadley told the panel. "The tax applies to the substance of the transaction, not just the form."

Senior 9th Circuit Judge Jay S. Bybee was skeptical of her argument, wondering why Congress didn't simply write the law differently.

"This would have been a very, very easy fix," said Bybee, an appointee of President George W. Bush who concurred in the unanimous panel decision.

Lewis Richard "Rich" Walton Jr., a partner with Walton & Walton in Marina Del Ray, said in a phone interview that tax advantages properly invoked cannot be undone "because the government thinks the result is too good" for the taxpayer.

He said Congress passed the Foreign Sales Corporation statute to boost U.S. businesses and the Roth IRA to help with retirement savings.