Celia Mazzei v. Cir

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

CELIA MAZZEI; ANGELO L. MAZZEI; No. 18-72451

MARY E. MAZZEI,

Petitioners-Appellants, Tax Ct. Nos.

16702-09

v. 16779-09

COMMISSIONER OF INTERNAL

REVENUE, OPINION

Respondent-Appellee.

Appeal from a Decision of the

United States Tax Court

Argued and Submitted February 14, 2020

Pasadena, California

Filed June 2, 2021

Before: Jay S. Bybee and Daniel P. Collins, Circuit Judges,

and Barry Ted Moskowitz, * District Judge.

Opinion by Judge Collins

*

The Honorable Barry Ted Moskowitz, United States District Judge

for the Southern District of California, sitting by designation.

2 MAZZEI V. CIR

SUMMARY **

Tax

The panel reversed a decision by the full Tax Court in

favor of the Commissioner on a petition for redetermination

of federal excise tax deficiency, in a case involving the use

of a Foreign Sales Corporation to reduce the tax paid on

income that was then distributed as dividends to Roth

Individual Retirement Accounts.

Appellants established a FSC under since-repealed

provisions of Internal Revenue Code §§ 921–927 (the FSC

statute). Under the FSC statute, a corporation with foreign

trade income could establish a related FSC as a shell

corporation and then effectively cycle a portion of that

income through the FSC where it would be taxed at lower

rates. As a result, the FSC’s taxable income was generated

through related-party transactions that lacked meaningful

economic substance. The FSC taxation rules thus reflected a

departure from the normal principle that taxation is based on

economic substance rather than on legal form.

Appellants made their Roth IRAs formal shareholders of

their FSC. Appellants’ export corporation paid commissions

into the FSC, and the FSC’s after-tax income was returned

as dividends and distributed to appellants’ IRAs rather than

to their export corporation. As a result, no tax was paid when

the money was received into the Roth IRAs, and no tax

would be paid on qualified withdrawals from the Roth IRAs.

**

This summary constitutes no part of the opinion of the court. It

has been prepared by court staff for the convenience of the reader.

MAZZEI V. CIR 3

The Commissioner challenged this scheme, asking the

Tax Court to recharacterize the entire scheme under the

doctrine of substance over form. The Tax Court held that,

under substance-over-form principles, appellants—not the

Roth IRAs—were the real owners of the FSC. This meant

that appellants should be deemed to have received the

dividends, their contributions to the Roth IRAs exceeded the

statutory limits for such contributions, and appellants were

consequently liable for excise taxes on the excess

contributions.

The panel concluded that, due to the unusual statutory

provisions at issue here, the Tax Court erred by invoking

substance-over-form principles to effectively reverse

congressional judgment and to disallow what the statute

plainly allowed. The panel joined three other circuits that

have similarly disallowed the invocation of substance-over-

form principles to undo the congressionally authorized

separation of substance and form that is involved in an entity

similar to the FSC at issue here.

COUNSEL

Lewis R. Walton Jr. (argued) and Lewis R. Walton, Walton

& Walton LLP, Marina Del Ray, California, for Petitioners-

Appellants.

Judith A. Hagley (argued), Gilbert S. Rothenberg, and

Teresa E. McLaughlin, Attorneys, Tax Division; Richard E.

Zuckerman, Principal Deputy Assistant Attorney General;

United States Department of Justice, Washington, D.C.; for

Respondent-Appellee.

4 MAZZEI V. CIR

OPINION

COLLINS, Circuit Judge:

Angelo, Mary, and Celia Mazzei appeal the Tax Court’s

ruling that they are liable for excise taxes for having made

excess contributions to their Roth Individual Retirement

Accounts (“IRAs”). Invoking substance-over-form

principles, the Commissioner insists that the dividends that

the Mazzeis’ Roth IRAs received from a specific corporation

were actually contributions from the Mazzeis, because the

Commissioner deemed the Mazzeis, rather than the IRAs, to

be the real owners of that corporation. Over the vigorous

dissent of four judges, the full Tax Court sided with the

Commissioner. Because we conclude that the unusual

statutory provisions at issue here expressly elevated form

over substance in the relevant respects, the Tax Court erred

by invoking substance-over-form principles to effectively

reverse that congressional judgment and to disallow what the

statute plainly allowed.

The underlying dispute arises from the Mazzeis’

establishment of a Foreign Sales Corporation (“FSC”) under

the since-repealed provisions of Internal Revenue Code

§§ 921–927 (“the FSC statute”). As we explain in detail

below, FSCs were an unusual type of corporation that

Congress first authorized in 1984 to promote exports and

that the World Trade Organization held in 2000 constituted

an impermissible trade subsidy. Under the FSC statute, a

corporation with foreign trade income could establish a

related FSC as a shell corporation and then effectively cycle

a portion of that income through the FSC where it would be

taxed at lower rates. Specifically, the export corporation

could pay tax-deductible “commissions” to the FSC that did

not correspond to any actual services provided by the FSC

but that were instead determined according to complex

MAZZEI V. CIR 5

statutory formulas. The FSC would pay a modest tax on the

resulting income, and the FSC would then return the

remaining income back to the export corporation (or a

related entity) as dividends, usually tax-free. As a result, the

FSC’s taxable income was largely generated through

related-party transactions that lacked meaningful economic

substance, and the FSC taxation rules thus reflected a sharp

departure from the normal principle that taxation is based on

economic substance rather than on legal form.

The Mazzeis (and many others) took this one step further

by having their Roth IRAs be the formal shareholders of the

FSC. This meant that, when the FSC’s after-tax income was

being returned as dividends, it was distributed to the IRAs

rather than to the export corporation that had paid the

commissions into the FSC. As a result, no tax was paid when

the money was received into the Roth IRAs, no tax would be

paid on the growth of those funds over time, and no tax

would be paid if and when the Mazzeis made qualified

withdrawals from the Roth IRAs. The Commissioner

thought that this arrangement was too good to be true, and

he challenged what the Mazzeis had done here, as well as

similar arrangements involving other taxpayers invoking

related strategies. The Tax Court declined to adopt the

Commissioner’s broad effort to recharacterize the relevant

transactions as a whole, and the court instead held only that,

under substance-over-form principles, the Mazzeis rather

than the Roth IRAs were the real owners of the FSC. That

meant that the Mazzeis should be deemed to have received

the dividends. And that meant, in turn, that the Roth IRAs

received those funds as contributions from the Mazzeis, and

these were well in excess of the statutory limits on such

contributions. As a result, the Tax Court concluded, the

Mazzeis were liable for excise taxes on the excess

contributions.

6 MAZZEI V. CIR

Three circuits have addressed comparable questions in

the context of a similar type of corporation allowed by the

Internal Revenue Code, namely, a Domestic International

Sales Corporation (“DISC”). All three courts reversed the

Tax Court and disallowed the invocation of substance-over-

form principles to undo the congressionally authorized

separation of substance and form that is involved in a DISC.

We reach a similar conclusion as to FSCs here, and we

therefore reverse the judgment of the Tax Court.

I

This is a case in which the details matter a great deal, and

so we first set forth the complex legal backdrop and then

explain the specific facts of this case.

A

The legal context for this dispute involves three different

entities that are (or were) specially authorized by the Internal

Revenue Code, namely, Roth IRAs, FSCs, and DISCs.

Although the Mazzeis did not use a DISC, the FSC regime

was expressly modeled after the DISC system, and so an

understanding of the latter will help to elucidate the

distinctive features of the former. Moreover, the only circuit

decisions addressing comparable issues arose in the DISC

context, thereby underscoring the importance of

understanding both types of corporations. Accordingly, we

briefly review the key features of the Roth IRA, DISC, and

FSC.

1

Congress first authorized tax-advantaged IRAs in 1974,

initially as a means of providing retirement assistance to

those who lacked coverage under a pension plan. See

MAZZEI V. CIR 7

Employee Retirement Income Security Act of 1974, Pub. L.

93-406, § 2002, 88 Stat. 829, 958–64. Congress has

substantially expanded the availability of IRAs since then,

and it has made numerous changes to the tax treatment of

such accounts. In particular, Congress in 1997 authorized a

new alternative type of IRA called a “Roth IRA.” See

Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 302(a),

111 Stat. 788, 825.

The tax treatment of earnings in a Roth IRA are generally

the same as for a traditional IRA: earnings grow tax-free,

except that they remain “subject to the taxes imposed by

section 511” concerning unrelated business income. I.R.C.

§ 408(e)(1). But the tax treatment of contributions and

withdrawals differs sharply for a Roth IRA versus a

traditional IRA. With a traditional IRA, authorized

contributions into the account are deductible from taxable

income, see id. § 219(a), but subsequent authorized

withdrawals are generally subject to taxation as ordinary

income, see id. § 408(d)(1). For a Roth IRA, these rules are

reversed: no deduction is allowed for a contribution into a

Roth IRA, see id. § 408A(c)(1), but distributions from a

Roth IRA are not taxable, id. § 408A(d)(1). Loosely

speaking, money is taxed only before going into a Roth IRA,

and money is taxed only on the way out of a traditional IRA.

Given the significant tax advantages of a Roth IRA, in

which funds grow tax free and then remain free from

taxation upon authorized distribution, Congress has

established a statutory formula that strictly limits

contributions to Roth IRAs. See I.R.C. § 408A(c). Under

that formula, as a taxpayer’s income increases, the

contribution limit generally decreases. Id. To enforce such

contribution limits to Roth IRAs (as well as other tax-

favored vehicles), Congress has imposed a 6 percent tax on

8 MAZZEI V. CIR

excess contributions, subject to the proviso that the amount

of the tax cannot exceed 6 percent of the value of the

account. Id. § 4973(a), (f). Moreover, a comparable excise

tax is imposed each subsequent year unless and until an

amount corresponding to the excess contribution is properly

removed from the Roth IRA. Id. § 4973(b)(2).

2

To promote exports of domestic goods, Congress in 1971

authorized the creation of DISCs, which are governed by

special rules that allow companies to reduce the taxes they

pay on export income. See Revenue Act of 1971, Pub. L.

No. 92-178, §§ 501–507, 85 Stat. 497, 535–53. The DISC

system has been amended over the intervening years, and we

briefly sketch its key features in their present form.

The central feature of the DISC system is a special

statutory exception for DISCs from the normal rules that

govern allocation of income between “two or more

organizations, trades, or businesses . . . owned or controlled

directly or indirectly by the same interests.” I.R.C. § 482.

Under this statutory exception, the shareholders of a

corporation with products to export can create a commonly

controlled DISC and then “sell” those products “to the DISC

at a hypothetical ‘transfer price’ that produce[s] a profit for

both seller [i.e., the export corporation] and buyer [i.e., the

DISC] when the product [is] resold to the foreign customer.”

Boeing Co. v. United States, 537 U.S. 437, 441 (2003)

(emphasis added). This hypothetical “transfer price” for the

sale of goods between the two commonly controlled entities

is not based on any underlying economic reality, but is

instead set artificially in accordance with a complex

statutory formula. I.R.C. § 994(a) (explicitly stating that, in

the case of a “sale of export property” to the DISC, income

can be allocated to the DISC in accordance with the statutory

MAZZEI V. CIR 9

formula “regardless of the sales price actually charged”).

The details of that statutory formula are not relevant here.

What matters is that the ultimate consequence of these rules

is effectively to reallocate a portion of the company’s export

income to the DISC, where that income would not be subject

to corporate income tax. See id. § 991.

Although the statute itself articulates these special rules

only in the context of the “sale of export property to a DISC”

by a commonly controlled entity, I.R.C. § 994(a) (emphasis

added), the statute also instructs the Secretary of the

Treasury to issue regulations establishing comparable rules

applicable in “the case of commissions, rentals, and other

income” between a DISC and a commonly controlled entity,

id. § 994(b) (emphasis added). The Secretary has issued

such regulations, which allow an export corporation to

obtain comparable advantages by paying a hypothetical

“commission” to a commonly controlled DISC for the

latter’s provision of export services. See 26 C.F.R. § 1.994-

1(d)(2). These regulations set forth specific instructions for

calculating the “maximum commission the DISC may

charge” the export corporation and the “amount of the

income that may be earned by the DISC in any year” in

connection with “qualified export receipts.” Id. § 1.994-

1(d)(2)(i)–(ii). Once again, the details of these formulas are

not relevant for present purposes. The key point is that,

under these special rules, an export corporation may pay a

tax-deductible “commission” to the DISC in an amount that,

as a general matter, is explicitly divorced from the value of

any services actually provided by the DISC. See id. § 1.994-

1(a)(2) (application of these rules “does not depend on the

extent to which the DISC performs substantial economic

functions (except with respect to export promotion

expenses)”); see also id. § 1.993-1(k)(1) (to earn such

commissions, “such DISC need not have employees or

10 MAZZEI V. CIR

perform any specific function”). 1 The DISC, in turn, is

generally exempt from any tax on its income from these

commissions. I.R.C. § 991.

As a result of these unique rules, neither the export

corporation nor the DISC pays any income tax on the

applicable income that is attributable to the corporation’s

qualified export receipts but that was effectively allocated to

the DISC by way of (as the case may be) the hypothetically

priced sale or the artificially determined “commissions.”

Income tax is generally only paid when the DISC distributes

its received commissions as dividends to the DISC’s

shareholders, either because the DISC actually pays out the

dividends, see I.R.C. §§ 1(h)(11), 246(d), or because,

according to a detailed statutory formula, the shareholder is

deemed to have “received a distribution taxable as a

dividend with respect to his [or her] stock,” id. § 995(b)(1).

1

The regulation gives the following stark example to illustrate just

how much of a shell a DISC can be and still earn commissions:

P Corporation forms S Corporation as a wholly-owned

subsidiary. S qualifies as a DISC for its taxable year.

S has no employees on its payroll. S is granted a sales

franchise with respect to specified exports of P and

will receive commissions with respect to such exports.

Such exports are of a type which will produce gross

receipts for S which are qualified export receipts as

defined in paragraph (b) of this section. P’s sales force

will solicit orders in the name of P. Billings and

collections are handled directly by P. Under these

facts, the commissions paid to S for such taxable year

with respect to the specified exports shall be treated

for Federal income tax purposes as the income of S,

and the amount of income allocable to S is determined

under section 994 of the Code.

26 C.F.R. § 1.993-1(k)(3) (example 2).

MAZZEI V. CIR 11

The “net effect” of these complex rules is thus to allow an

export company to ultimately transfer a portion of its export

revenue to the DISC’s shareholders (who are often either the

export company or its shareholders) in the form of dividends,

without having it ever being taxed “as corporate income.”

Summa Holdings, Inc. v. Commissioner, 848 F.3d 779, 782

(6th Cir. 2017).

The Internal Revenue Code explicitly contemplates that

tax-exempt entities—a category that now includes Roth

IRAs—may own shares of a DISC. It does so by

establishing a special rule that applies when the “shareholder

in a DISC” is an “organization . . . subject to tax under

section 511.” See I.R.C. § 995(g). As noted earlier, that

category includes traditional IRAs and, since their

authorization in 1997, Roth IRAs. See id. § 408(e)(1)

(stating that, although IRAs are generally exempt from

income taxation, they are “subject to the taxes imposed by

section 511”); see also supra at 7. Under this special rule,

when an IRA owns the shares of a DISC, any dividends

distributed, or deemed distributed, to the IRA are generally

“treated as derived from the conduct of an unrelated trade or

business,” I.R.C. § 995(g), and therefore subject to taxation

under § 511. That unrelated-business-income tax rate is

“equal to the corporate rate,” which is generally higher than

the “dividend rate” that would apply to DISC dividends paid

to an individual shareholder of a DISC. See Benenson v.

Commissioner, 910 F.3d 690, 694 (2d Cir. 2018). 2 As a

result, when a traditional IRA holds shares in a DISC, the

“DISC dividends are subject to high unrelated business

income tax when they go into [that] traditional IRA and, like

2

When a corporation that is subject to income tax is the owner of a

DISC’s shares, it must generally pay income tax, at the corporate rate,

on dividends received from a DISC. I.R.C. § 246(d).

12 MAZZEI V. CIR

all withdrawals from [a] traditional IRA, are subject to

personal income tax when taken out.” Id. (emphasis added)

(citing Summa Holdings, 848 F.3d at 783). That makes a

traditional IRA a singularly unattractive vehicle for holding

DISC shares. Id. And that is no accident—Congress enacted

the special taxation rule in § 995(g) in 1989 precisely

because, under the prior rule in which “tax-exempt entities

like IRAs paid nothing on DISC dividends,” export

companies were “shield[ing] active business income from

taxation by assigning DISC stock to controlled tax-exempt

entities like pension and profit-sharing plans.” Summa

Holdings, 848 F.3d at 782.

But the situation with a Roth IRA is somewhat different.

To be sure, a Roth IRA, like a traditional IRA, generally

must still pay unrelated-business-income tax on dividends

received from a DISC. I.R.C. §§ 511, 995(g). However,

once those monies are safely in a Roth IRA, they can

thereafter grow tax-free and—unlike a traditional IRA—

they are not subject to income tax when they are properly

distributed out of the Roth IRA. For some taxpayers, that

can make a Roth IRA an attractive vehicle for holding DISC

shares.

3

“Soon after its enactment, the DISC statute became ‘the

subject of an ongoing dispute between the United States and

certain other signatories of the General Agreement on Tariffs

and Trade (GATT)’ regarding whether the DISC provisions

were impermissible subsidies that violated our treaty

obligations.” Boeing Co., 537 U.S. at 442 (citation omitted).

As a result, Congress in 1984 authorized a distinct but

similar entity known as a “Foreign Sales Corporation” or

“FSC.” See Deficit Reduction Act of 1984, Pub. L. No. 98-

369, §§ 801–805, 98 Stat. 494, 985–1003. The hope was that

MAZZEI V. CIR 13

the FSC system, which would serve as an alternative to a

modified DISC scheme, would ameliorate such international

controversy. Boeing Co., 537 U.S. at 442. That hope proved

illusory, and the FSC regime itself was determined by the

World Trade Organization in March 2000 to be “an

impermissible subsidy.” Ford Motor Co. v. United States,

908 F.3d 805, 808 (Fed. Cir. 2018). Congress promptly

repealed the FSC provisions in November 2000, but the

repeal statute contained transition provisions that allowed

for certain existing FSCs to continue for a specified time.

See FSC Repeal and Extraterritorial Income Exclusion Act

of 2000, Pub. L. No. 106-519, 114 Stat. 2423. 3 Throughout

all of this, Congress did not eliminate the alternative DISC

regime, whose current form we described earlier. See supra

at 8–12.

The statutory provisions governing FSCs were set forth

in former §§ 921–927 of the Internal Revenue Code. 4 In

3

Specifically, § 5 of the repeal statute specified that FSCs could not

be formed after September 30, 2000, but that for active FSCs in existence

as of that date, the repeal generally would not apply to transactions

involving the FSC (1) that occurred before January 1, 2002; or (2) that

occurred after December 31, 2001, pursuant to certain binding contracts

in effect on September 30, 2000. See Pub. L. No. 106-519, § 5(b)(1),

(c), 114 Stat. at 2433. (The second of these transitional rules, concerning

transactions pursuant to certain binding contracts, was itself later

repealed for taxable years beginning after May 17, 2006. See Tax

Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-

222, § 513(a), 120 Stat. 345, 366 (2006).)

4

All citations of those sections in this opinion refer to the 1999

edition of the Code, which is available at

https://www.govinfo.gov/app/collection/uscode/1999/. Likewise, all

citations of the regulations governing FSCs refer to the 1999 edition of

the Code of Federal Regulations.

14 MAZZEI V. CIR

contrast to DISCs, which are domestic corporations, a FSC 5

generally must be organized under the laws of certain

foreign countries or under the laws applicable to a U.S.

possession. I.R.C. § 922(a)(1)(A). The centerpiece of the

FSC system was similar to that of the DISC system, viz., an

explicit statutory exception from the ordinary rules that

govern allocation of income between “two or more

organizations, trades, or businesses . . . owned or controlled

directly or indirectly by the same interests.” Id. § 482.

Specifically, the shareholders of an export corporation could

create a commonly controlled FSC and then make “sale[s]

of export property” to the FSC at hypothetical “transfer

price[s]” that were fixed by a complex statutory formula

“regardless of the sales price actually charged.” Id. § 925(a).

As with the DISC system, the FSC statute required the

Secretary to issue regulations that would establish

comparable rules “in the case of commissions, rentals, and

other income,” id. § 925(b)(1), and the Secretary did so, see,

e.g., 26 C.F.R. § 1.925(a)-1T(d)(2). Similar to their DISC

counterparts, these regulations set forth specific instructions

for calculating the “maximum commission the FSC may

charge” the export corporation and the “amount of the

income that may be earned by the FSC in any year.” Id.

§ 1.925(a)-1T(d)(2)(ii), (iv). Once again, the details of these

formulas are not relevant here. What matters is that the

formulas allowed the FSC’s commissions and income to be

set at artificial levels that did not necessarily correspond to

the actual value of any services provided by the FSC. See

id. § 1.925(a)-1T(a)(3) (application of certain pricing rules

5

There appears to be some debate as to whether the phrase should

be “a FSC” (which assumes that the term is pronounced “a Fisc”) or

should instead be “an FSC” (which assumes that it is pronounced “an F-

S-C”). We follow the statute, which consistently uses the phrase “a

FSC.” See, e.g., I.R.C. § 921(a).

MAZZEI V. CIR 15

“does not depend on the extent to which the FSC performs

substantial economic functions beyond those required by

section 925(c)”).

In contrast to a DISC, whose income is generally exempt

from tax, see I.R.C. § 991, a FSC’s income was partially

subject to tax. Specifically, after an export company paid

tax-deductible commissions to its related FSC, a statutorily

specified portion of the FSC’s income attributable to those

commissions was declared to be “exempt foreign trade

income.” Id. § 923(a)(1); see also id. §§ 923(b), 924(a). The

statute stated, in turn, that “[e]xempt foreign trade income”

would be “treated as foreign source income which is not

effectively connected with the conduct of a trade or business

within the United States,” thereby exempting such income

from taxation. Id. § 921(a). 6 The remaining non-exempt

portion of the FSC’s foreign trade income, however, was still

subject to the corporate income tax rate. The net effect of

these provisions was to allow an export corporation to

allocate a portion of its export sales income to the FSC by

paying the FSC artificially determined “commissions,” with

the consequence that the export corporation paid no income

tax on any of the commissions (which it deducted as an

expense) and the FSC paid income tax only on the non-

exempt portion of its income attributable to those

commissions.

6

To take advantage of these rules, a FSC generally had to be

managed, and transact its business, outside the United States. I.R.C.

§ 924(b)(1), (c), (d). However, those requirements generally did not

apply to a “small FSC,” id. § 924(b)(2)(A), as that term was defined by

statute, id. § 922(b). It is undisputed that the relevant FSC in this case

was a “small FSC,” and it therefore was not subject to these additional

requirements.

16 MAZZEI V. CIR

The taxation of a FSC’s dividend payments differs in

some respects from those of a DISC. Dividends that are

distributed by a FSC to a domestic parent corporation out of

the earnings and profits attributable to the FSC’s foreign

trade income are generally not subject to corporate income

tax. I.R.C. § 245(c)(1)(A). This allowed the export

corporation to effectively allocate income to the FSC, where

it was subject to reduced taxation, and then to receive back

some of those funds as dividends without paying income tax

on them. The Commissioner estimates that the bottom-line

result of these complex rules was to allow “a U.S.

manufacturer to reduce its corporate income tax on export

sales by approximately 15%.”

If the FSC paid dividends to individual shareholders,

then those dividends would generally be subject to taxation

under the default rule that dividends are treated as income.

See I.R.C. § 1(h)(11). By contrast, if an IRA was the

shareholder of the FSC, then any FSC dividend received by

the IRA, like almost any other income to the IRA, is exempt

from taxation. See id. § 408(e)(1). Although the general rule

against taxation of IRA income does not apply to “unrelated

business income” that is taxed under § 511, see id.

§ 408(e)(1), the default rule under the Code is that dividends

are excluded from “unrelated business taxable income,” id.

§ 512(a)(1), (b)(1). As noted earlier, see supra at 11–12, the

Code contains a special provision that expressly reverses

that default rule in the case of dividends paid by “a DISC”

to a tax-exempt entity (such as an IRA), see id. § 995(g), and

that means that an IRA must pay tax on such “unrelated

business income” under § 511, see id. § 408(e)(1). But the

Code contains no such similar provision with respect to

dividends of a FSC that are paid to a tax-exempt shareholder,

such as an IRA, and so the default rule remains in place. And

if the IRA that owned the FSC shares was a Roth IRA, as

MAZZEI V. CIR 17

opposed to a traditional IRA, then the authorized

distributions from the IRA to the individual holder of the

account would not be taxed either. The net result of having

a Roth IRA hold the shares of a FSC would thus be that

(1) the export corporation would pay no tax on the income it

allocated as “commissions” to the FSC; (2) the FSC would

pay only a reduced level of corporate income tax on the

income attributable to its commissions; (3) the Roth IRA

would pay no tax when it received dividends from the FSC;

and (4) the individual IRA holder would pay no tax when

receiving the FSC dividends in the form of authorized IRA

distributions. That is, only one of these four transactions

would be taxable and that one only at a reduced effective

rate.

B

With this complex statutory background in place, we can

now turn to the facts of this case. We first describe the

Mazzeis’ relevant transactions and then recount the

proceedings below.

1

In 1977, Angelo Mazzei filed a patent application for an

“injector” that added fertilizers to the water used in

agricultural irrigation systems. The following year,

recognizing the business potential in his invention, Angelo

and his wife Mary Mazzei formed the Mazzei Injector Corp.

(“Injector Corp.”) as an S corporation. 7 Angelo and Mary

7

“S corporations” are ordinary business corporations that elect to

pass corporate income, losses, deductions, and credits through to their

individual shareholders for federal tax purposes. See I.R.C. §§ 1361–

1379. Thus, the S corporation generally pays no income tax, and the

shareholders of S corporations instead report the flow-through of income

18 MAZZEI V. CIR

thereafter actively ran the business, although Mary later

reduced her role. Once their daughter, Celia, graduated from

college, she became more active in the company and served

as its vice president of research and development. During

the time period at issue in this case, Angelo and Mary each

owned 45 percent of Injector Corp. while Celia owned the

remaining 10 percent. Through the Mazzeis’ efforts,

Injector Corp. grew rapidly, and by 1984, the business began

exporting its products through foreign distributors. By the

late 1990s, export sales provided a steady stream of revenue

to Injector Corp.

The Mazzeis also owned a 20-acre farm, and as a result

they were long-time members of the Western Growers

Association (“WGA”), a trade association representing

farmers. In the 1990s, WGA developed a program for its

members that would facilitate their use of FSCs, and in 1998

the Mazzeis decided to participate in that program. In

connection with doing so, the Mazzeis took steps to set up

Roth IRAs. The amount that may be contributed to a Roth

IRA is determined according to a statutory formula, see

I.R.C. § 408A(c), and for the years prior to 1998, each of the

Mazzeis’ contribution limits to a Roth IRA was zero.

Through a complex business restructuring that the

Commissioner does not challenge here, each of the Mazzeis

had a Roth IRA contribution limit of $2,000 for 1998 only.

Under that restructuring, the Mazzeis formed another S

corporation, ALM Corp., which was owned in the same

proportions as Injector Corp. ALM Corp. and Injector

and losses on their personal tax returns and pay tax at their individual

income tax rates. Id. §§ 1363(a), 1366. In this way, S corporations avoid

the problem of double taxation in which the corporation would first pay

tax on its income and then the individual shareholder would pay tax on

distributions received from the corporation.

MAZZEI V. CIR 19

Corp., in turn, then formed Mazzei Injector Co. (“Injector

Co.”), an LLC that was treated as a partnership for tax

purposes. Having secured a Roth IRA contribution limit of

$2,000 for 1998, each of the Mazzeis opened a Roth IRA and

contributed $2,000. However, in the ensuing four calendar

years (1999 through 2002), the Roth IRA contribution limits

for each of the Mazzeis reverted back to zero.

Meanwhile, the newly formed entity, Injector Co.,

applied to join WGA’s FSC program. Once WGA approved

Injector Co.’s application, the Mazzeis took steps to

establish a FSC under WGA’s auspices. The WGA FSC

program took advantage of the statute’s allowance of a

“shared FSC,” under which an entity (such as WGA) could

arrange for a FSC to maintain “separate account[s]” that

each would then generally “be treated as a separate

corporation for purposes” of the FSC statute. I.R.C.

§ 927(g)(1), (g)(3)(A). In formally establishing their FSC as

a separate account in one of WGA’s shared FSCs, the

Mazzeis arranged for their separate Roth IRAs to each

purchase 33⅓ shares of their FSC, at a total price of $500 for

the 100 shares. The Mazzeis also elected to have their FSC

treated as a “small FSC,” which meant that it was not subject

to the same foreign-presence requirements as regular FSCs.

See supra note 6.

WGA also provided Injector Co. with drafts of the

various agreements that would be needed to ensure that its

FSC—which was ultimately a separate account in the

“Western Growers Shared Foreign Sales Corporation IV

Ltd.” (“WG FSC IV”) 8—would be able to operate as

8

The relevant shared FSC was originally “Western Growers Shared

Foreign Sales Corporation III Ltd.,” but because the change makes no

difference here, we will refer only to “WG FSC IV.” And because

20 MAZZEI V. CIR

intended, and Injector Co. executed these agreements in

early 1998. These various agreements underscore what the

statutory framework expressly contemplates, which is that

the FSC would be paid commissions that were set according

to regulatory formulas and that did not reflect any actual

services provided by the FSC.

First, Injector Co. and WG FSC IV executed a “Foreign

Trade Commission, Sale, License, Lease and Services

Agreement” (“Commission Agreement”), under which WG

FSC IV agreed to perform certain activities and services for

Injector Co. “but only to the extent it can delegate such

activities and services” back to Injector Co. “and is not

required to use its own assets and/or personnel to perform

such activities and services” (emphasis added). Thus, for

example, WG FSC IV agreed to “promote the license, lease

and sale” of Injector Co.’s products, but it also stated that

none of these activities “shall be of the type which involve

the use of the FSC’s own assets or personnel to perform such

activities.” The Commission Agreement also specified that

if a particular sale, license, or lease was “considered as

solicited or promoted” by WG FSC IV, then the FSC would

receive a commission, but that Injector Co. would have the

“final decision” as to whether the FSC was to be “considered

as having solicited or promoted a transaction” (emphasis

added). If a commission was to be paid, then it would be

determined by mutual agreement in accordance with the

formulas in the applicable federal FSC regulations “so as to

provide the maximum federal income tax benefits” to

Injector Co. Likewise, the Commission Agreement

specified that if Injector Co. “performs any service for a

nothing turns on the distinction here, we will also for the sake of

simplicity use “WG FSC IV” interchangeably to refer to both the shared

FSC and the Mazzeis’ separate account within that shared FSC.

MAZZEI V. CIR 21

customer that would constitute” a relevant service “if

performed by [WG FSC IV] for a customer considered as

solicited or promoted” by the FSC, then Injector Co. would

pay a “commission” to the FSC. Once again, Injector Co.

had the “final decision” as to whether WG FSC IV would be

“considered” to have solicited or promoted a transaction, and

any commission paid would be determined by mutual

agreement in accordance with the relevant regulatory

formulas.

Second, consistent with what was expressly

contemplated in the Commission Agreement, the “Export

Related Services Agreement” (“Services Agreement”)

formally delegated back to Injector Co. the relevant

activities and services that WG FSC IV was to perform in

connection with “earning foreign trade income.” WG FSC

IV agreed to pay Injector Co. a “service fee” for performing

these services, but any such fee could not exceed the

commissions that the FSC received and was to be

“immediately offset against the discretionary commissions

which [Injector Co.] would otherwise pay to [the FSC].”

The agreement further provided that services would be

deemed to have been performed by Injector Co. for WG FSA

IV only to the extent required to “maxim[ize] federal income

tax benefits.”

Third, under the “Management Contract,” WG FSC IV

agreed to pay “administrative fees” to Quail Street

Management (“Quail Street”), the Bermuda-based

management company that administered WGA’s FSC

program. The fee was set at 0.1 percent of the FSC’s foreign

gross trading receipts as defined in Internal Revenue Code

§ 924. The fee had to be at least $3,500 and at most $10,000.

Fourth, under the “Shareholders’ Agreement,” each IRA

shareholder owned one-third of their FSC’s 100 shares,

22 MAZZEI V. CIR

which could not be sold without the approval of the FSC’s

directors. The agreement confirmed the $500 purchase price

for the 100 shares and specified that this amount consisted

of $1 of “paid-in capital” and $499 of “paid-in surplus.” The

agreement further stated that, in the event that the FSC

exercised its right to purchase the FSC stock from the

shareholders, the purchase price would be the paid-in-capital

amount ($1). However, the agreement specified that this

right of purchase did not apply in the case of an “IRA

Shareholder” and that any such sale by an IRA Shareholder

to the FSC was prohibited.

With these agreements in place, Injector Co. thereafter

reported its foreign sales to Quail Street each quarter. Based

on these numbers, Quail Street computed the maximum

commission that Injector Co. was allowed to pay to the FSC

in accordance with the federal FSC regulatory formulas.

Quail Street then reported that amount in letters to the

Mazzeis that identified (1) the amount of the FSC tax that

had been paid (and that had to be reimbursed); 9 and (2) the

remainder amount that could be distributed to the IRA

shareholders. In accordance with these instructions, Injector

Co. paid a total of $558,555 in commissions and taxes to WG

FSC IV between 1998 and March 2002. In turn, the FSC

paid $533,057 in dividends to the Mazzeis’ Roth IRAs over

that same time period.

9

As explained earlier, only a portion of the commissions received

by a FSC are untaxed, see supra at 15, and so the FSC here paid tax on

a portion of Injector Co.’s payments and distributed the rest to the

Mazzeis’ Roth IRAs. The Roth IRAs did not pay tax on these FSC

dividends, but had the dividends instead been paid to the Mazzeis

individually, they would have owed tax on the dividends. See supra

at 16.

MAZZEI V. CIR 23

Through these various steps, the Mazzeis took full

advantage of the tax benefits described earlier. See supra

at 17. The corporations that generated the foreign sales

ultimately benefitted from a tax deduction for the

“commissions” paid to the FSC. WG FSC IV paid a modest

amount of tax on the income attributable to its commissions.

The Roth IRAs paid no tax on the substantial dividends they

received from the FSC because (unlike § 995(g) in the case

of a DISC) there is no statutory provision imposing such a

tax in the case of a FSC. And, now that the funds are safely

in the Roth IRAs, they can be withdrawn by the Mazzeis tax

free when they are eligible to make such withdrawals.

2

Unsurprisingly, the Commissioner did not like this

arrangement. On April 6, 2009, the Commissioner served

notices of deficiency against each of the Mazzeis. The

Commissioner asserted that the $533,057 that had been paid

by WG FSC IV into their respective Roth IRAs should be

deemed, in substance, to be contributions to their Roth IRAs

that exceeded their statutory contribution limits. For tax

years 2002 through 2007, the Commissioner asserted excise

tax deficiencies against Angelo and Mary (who filed joint

returns) in the amount of $67,590, as well as penalties

totaling $19,215. 10 For tax years 2002 through 2007, the

Commissioner asserted against Celia excise tax deficiencies

of $40,692 and penalties totaling $11,912. All three

petitioned the Tax Court for a redetermination of the

deficiency in tax, and the cases were consolidated.

10

The penalties were imposed for failing to timely file a tax return,

see I.R.C. § 6651(a)(1), and for failing to timely pay the tax shown on a

return, see id. § 6651(a)(2).

24 MAZZEI V. CIR

The consolidated case was tried on November 20, 2014

before Judge Mark Holmes. After Judge Holmes circulated

his proposed opinion within the Tax Court, the full Tax

Court determined to decide the matter. See I.R.C. § 7460(b);

see also Mazzei v. Commissioner, 150 T.C. 138, 184 n.1

(2018) (Holmes, J., dissenting). The Tax Court ultimately

upheld the Commissioner’s assessment of excise taxes

against the Mazzeis by a vote of 12 to 4 (with Judge Holmes

dissenting), but the Tax Court unanimously set aside all of

the penalties. Mazzei, 150 T.C. at 168, 182. Invoking the

doctrine of substance over form, the Tax Court concluded

that the Roth IRAs’ purchase of the FSC stock did not reflect

“the underlying reality” because the “Roth IRAs effectively

paid nothing for the FSC stock, put nothing at risk, and from

an objective perspective, could not have expected any

benefits” from that ownership. See id. at 167–68. The court

therefore “disregard[ed] the purchase” and treated the

Mazzeis as “the owners of the FSC stock for Federal tax

purposes at all relevant times.” Id. at 168. That meant that

the payments from the FSC must be “recharacterized as

dividends from the FSC” to the Mazzeis. 11 Id. And that

meant that the payments into the Roth IRAs were made by

the Mazzeis and were, therefore, excess contributions to the

Roth IRAs by the Mazzeis. Id.

The dissenters disagreed, asserting that the majority had

overlooked the import of the special rules that governed

FSCs, which expressly allowed transactions between

commonly held entities that lacked economic substance. In

11

The logic of the Tax Court’s reasoning would suggest that the

Mazzeis should have paid income taxes on those dividends. See supra

at 16. But as the Tax Court noted, “any income tax issues from 1998–

2001 are barred” by the “statute of limitations” in I.R.C. § 6501. See

150 T.C. at 149 n.15.

MAZZEI V. CIR 25

particular, the dissenters questioned the majority’s

conclusion that, because the Roth IRAs had “paid so little”

for their FSC stock and had put nothing at risk, they could

not be the true owners of the FSC. 150 T.C. at 192–93

(Holmes, J., dissenting). As the dissent explained, “the

Mazzeis also put nothing at risk to get the FSC, so by the

majority’s reasoning they couldn’t have owned the FSC

either.” Id. at 193. Indeed, the dissenters argued that, under

a consistent application of the majority’s reasoning, “no one

could ever own an FSC because FSCs never put capital at

risk.” Id.

The Mazzeis filed a motion for reconsideration and a

motion to vacate, which the Tax Court denied. The Mazzeis

timely appealed to this court.

II

In addressing the parties’ contentions on appeal, we

begin by identifying several points that are not in dispute. In

particular, the Commissioner does not contend that the

Mazzeis failed to follow any of the formalities required by

the Internal Revenue Code concerning the FSC or their Roth

IRAs. On the contrary, the Commissioner stipulated at trial

that WG FSC IV met all of the requirements for a small FSC;

that the Mazzeis’ Roth IRAs were properly established under

the Code; that there had not been a prohibited transaction

involving the Roth IRAs within the meaning of I.R.C.

§ 4975; and that compliance with I.R.C. § 482—which (as

noted earlier, see supra at 14) addresses allocation of income

and deductions among commonly controlled entities—was

“not at issue in this case.” Nor has the Commissioner

contended that any commissions that Injector Co. paid to the

FSC were calculated incorrectly under the applicable

statutory and regulatory formulas. See Mazzei, 150 T.C.

at 175.

26 MAZZEI V. CIR

Rather than contest whether the Mazzeis followed the

letter of the Code, the Commissioner instead asked the Tax

Court to “‘recharacterize [the Mazzeis’] entire scheme’”

under the “doctrine of substance over form.” See 150 T.C.

at 150. The Tax Court, however, expressly rejected the

Commissioner’s “request for a complete recharacterization

of all [of the Mazzeis’] transactions,” id. at 151, and the

Commissioner has not challenged that ruling in this court.

Instead, the Tax Court recharacterized only one of the

transactions at issue, viz., the purchase of the FSC’s stock by

the Roth IRAs. Id. Accordingly, the only issue before us is

whether the Tax Court properly concluded that, under the

substance-over-form doctrine, the Mazzeis, rather than their

Roth IRAs, were the owners of the FSC for federal tax

purposes.

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 questions of fact for clear error.” Knudsen v.

Commissioner, 793 F.3d 1030, 1033 (9th Cir. 2015). “We

review the Tax Court’s conclusions of law, including its

interpretations of the Internal Revenue Code, de novo.” Id.

“The general characterization of a transaction for tax

purposes is a question of law” subject to de novo review.

Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16

(1978); see also Sacks v. Commissioner, 69 F.3d 982, 986

(9th Cir. 1995).

A

It is a “black-letter principle” that, in construing and

applying the tax laws, courts generally “follow substance

over form.” PPL Corp. v. Commissioner, 569 U.S. 329, 340

(2013); see also United States v. Eurodif S.A., 555 U.S. 305,

317–18 (2009) (“[I]t is well settled that in reading regulatory

MAZZEI V. CIR 27

and taxation statutes, ‘form should be disregarded for

substance and the emphasis should be on economic reality.’”

(citation omitted)). Indeed, quoting Professor Boris Bittker,

we have described this “substance-over-form doctrine” and

other related doctrines as resembling, in combination, a sort

of “‘preamble to the Code, describing the framework within

which all statutory provisions are to function.’” Stewart v.

Commissioner, 714 F.2d 977, 987–88 (9th Cir. 1983)

(quoting Boris I. Bittker, Pervasive Judicial Doctrines in the

Construction of the Internal Revenue Code, 21 How. L.J.

693, 695 (1978)). Under these settled background

principles, this would be an easy case if it involved ordinary

business entities, as opposed to the distinctive vehicle of a

FSC. The taxpayers used what is essentially a shell

corporation to engage in arbitrarily priced, self-dealing

transactions that lacked economic substance and then

funneled those proceeds as “dividends” to a tax-free Roth

IRA. This would appear to present a paradigmatic case to

apply such doctrines. Cf., e.g., Repetto v. Commissioner,

103 T.C.M. (CCH) 1895, 2012 WL 2160440, at *9–12

(2012) (invoking substance-over-form doctrine where two

Roth IRAs respectively received dividends from commonly

controlled C corporations that received “service” payments

without themselves actually performing any business

services).

But like any background maxim that informs the

construction and application of a statute, the doctrine of

substance over form can be negated by Congress in express

statutory language. See Chickasaw Nation v. United States,

534 U.S. 84, 94 (2001) (interpretive “canons are not

mandatory rules” and “other circumstances evidencing

congressional intent can overcome their force”). Thus, there

are some circumstances “‘when form—and form alone—

determines the tax consequences of a transaction,’” Stewart,

28 MAZZEI V. CIR

714 F.2d at 988 (citation omitted), such as when “statutory

provisions deliberately elevate, or have been construed to

elevate, form above substance,” see 1 Boris I. Bittker &

Lawrence Lokken, Federal Taxation of Income, Estate and

Gifts ¶ 4.3.3, at 4-34 (3d ed. 1999). This is such a case. As

we have set forth in detail above, Congress has expressly

decreed that FSCs can engage in transactions, with

commonly controlled entities, that lack any economic

substance and that are assigned hypothetical values

determined according to statutory formulas that bear no

relationship to any underlying real-world valuation. See

supra at 13–15. Indeed, as this case well illustrates, the

entire FSC need not have any substance to it because it can

“contract” for another related entity to perform its relevant

activities. See I.R.C. § 925(c); see also 26 C.F.R.

§ 1.925(a)-1T(a)(3) (application of the relevant valuation

formulas “does not depend on the extent to which the FSC

performs substantial economic functions beyond those

required by section 925(c)”); Mazzei, 150 T.C. at 157 (noting

that, under the FSC regime, a “related supplier was permitted

to pay the FSC a ‘commission’ for services (relating to an

export transaction) that were not, in substance, performed by

the FSC (although the FSC could perform such services if it

wished)”). Put simply, the FSC statute expressly

contemplates that, without itself performing any services, a

FSC can receive “commissions” from a related entity and

then (after paying a reduced level of tax) the FSC can pay

the remainder as dividends to the same or another related

entity. Under the scheme that Congress devised in the FSC

statute, the taxation rules in certain respects plainly follow

the form of the matter and not its substance.

The question in this case, then, is whether the Tax Court

applied the substance-over-form doctrine in a manner that

properly takes account of Congress’s limited abrogation of

MAZZEI V. CIR 29

that doctrine here. The Tax Court construed that abrogation

very narrowly, saying that Congress endorsed form over

substance only with respect to the “specific transactions” in

which the export company pays commissions based on

statutory formulas that lack any economic reality, and then

“only for the purpose of computing the income taxes of the

FSC and its related supplier.” See Mazzei, 150 T.C. at 159

(emphasis added). Beyond that, the Tax Court concluded,

the FSC statute left the substance-over-form doctrine intact.

As that court stated, “[n]o part of the FSC statutes and

regulations states, or even implies, that purchases or

transfers of FSC stock, or any transactions at the shareholder

level or between the FSC and its owners, are exempt from

application of the substance doctrines, which are our normal

tools of statutory interpretation.” Id. at 160 (simplified).

The Tax Court therefore held that the FSC statute’s partial

abrogation of substance-over-form principles did not apply

“in deciding who actually owned the FSC stock” and that

that question was therefore governed by “normal substance

principles.” Id. at 154. While we share the Tax Court’s

concern that exemptions from normal substance-over-form

rules should not be read overly broadly, we cannot agree

with that court’s extremely restrictive view of the exemption

reflected in the FSC statute. In our view, the Tax Court’s

invocation of the substance-over-form doctrine in this case

rests on subsidiary premises that cannot be reconciled with

what Congress has decreed with respect to FSCs.

B

1

In applying normal substance-over-form principles to

the issue of the ownership of WG FSC IV, the Tax Court

considered whether the stockholders—i.e., the Roth IRAs—

had “the benefits and risks of ownership,” or whether some

30 MAZZEI V. CIR

other entity possessed them. 150 T.C. at 163. The court

noted that the Roth IRAs had put essentially nothing at risk

because the $500 “prearranged” price they paid for the FSC

stock bore no “relationship to the actual value” of that stock.

Id. at 165. The court concluded that the $500 the Roth IRAs

paid thus “represented at most a de minimis risk which was

insufficient to give substance to the Roth IRAs’ purported

ownership of the FSC stock.” 12 Id. at 164. The Tax Court

also addressed “what benefits an independent holder of the

FSC stock could realistically have expected on the basis of

the ‘objective nature’ of the FSC stock,” and the court

concluded that there were none: because “Injector Co.

retained complete control over whether any of its export

receipts would flow to the FSC in any year,” it followed that

“no independent holder of the FSC stock could realistically

have expected to receive any benefits (before or after tax)

due to its formal ownership of the FSC stock.” Id. at 166–

67. Because the Roth IRAs thus lacked the risks and benefits

of ownership, the court “disregard[ed]” their purchase of the

FSC stock. Id. at 168. Instead, the court concluded, the

Mazzeis (through Injector Co.) were the true owners of the

FSC. Id. And that meant that, under Commissioner v.

12

Indeed, the Tax Court suggested that, despite the parties’

agreement that the total stock was worth “$100 when it was purchased,”

the actual value was only $1 because that was the sale price set forth in

the Shareholders’ Agreement in the event that the shareholders sold their

stock. Mazzei, 150 T.C. at 165. The rest of the purchase price, according

to the Tax Court, was simply a fee to WGA. Id. This analysis appears

to overlook the fact that the $1 mandatory sale price, by its terms, only

applied to a purchase of the stock by WG FSC IV and that this option to

purchase did not apply if (as here) the stock was owned by an IRA.

Although a sale of the stock by the Roth IRAs to some other party would

still have required the approval of WG FSC IV’s directors, the agreement

does not appear to specify a price in such circumstances. In all events,

our analysis does not depend upon whether the value of the FSC stock at

the time of purchase was $1, $100, or $500.

MAZZEI V. CIR 31

Banks, 543 U.S. 426 (2005), the income of the FSC that was

paid out as dividends was, in the view of the Tax Court,

received by the Mazzeis for tax purposes. Mazzei, 150 T.C.

at 160–61 (“‘In an ordinary case attribution of income is

resolved by asking whether a taxpayer exercises complete

dominion over the income in question.’” (quoting Banks,

543 U.S. at 434)).

The problem with this analysis is that its underlying

premises are directly contrary to what is expressly

contemplated by the FSC statute. It makes no sense to ask

whether the formal owner of the FSC stock would, by virtue

of that purchase, be exposed to any risk as a result of that

ownership because the statute allows FSCs to be set up so as

to eliminate any risk from owning the FSC stock.

Specifically, the statute explicitly authorizes the

establishment of a FSC that will not conduct any operations

itself, and in such cases the FSC will effectively be a shell

corporation that generates value only by virtue of the

reduced rate of taxation that is paid on moneys that are

funneled through it in accordance with strict statutory

formulas. See supra at 13–17, 27–28. Such a shell

corporation presents little, if any, risk at all to its owner

because it will be used only if and when there is value (in the

form of tax savings) to be obtained by flowing funds through

it.

The Tax Court discounted this point, noting that

“nothing in the Code prevents an FSC shareholder from

capitalizing its FSC,” and such capital could be at risk.

Mazzei, 150 T.C. at 164 n.36 (emphasis added). This is an

ironic comment to make in an analysis that is supposedly

focused on economic realities. The reality is that, for a FSC

to function as the statute contemplates, there must be related

parties on both sides of the FSC, because the whole point of

32 MAZZEI V. CIR

the FSC vehicle is to cycle money through it so that it is

taxed at the FSC’s lower rate. The statute clearly envisions

that the parties who pay money into the FSC and the parties

who receive dividends out of it will be related. 13 Given that

reality, it would not make much economic sense to

“capitalize” the FSC with more than a nominal amount of

capital. As the dissenters noted, taking the Tax Court’s

analysis seriously would lead to the illogical conclusion that

“no one could ever own an FSC” because no owner would

ever “put capital at risk” in the FSC. Id. at 193 (Holmes, J.,

dissenting). The Tax Court also claimed that the Mazzeis

(unlike the Roth IRAs) did have risk because they were

“exposed at all times” to the risk “that their investment in

their export business would decline.” Id. at 165 n.37

(majority opinion). But this is the risk that the Mazzeis faced

as the owners of Injector Co.; it is not a risk that they would

face as the owners of the FSC.

Moreover, it makes even less sense to ask, as the Tax

Court did, “what benefits an independent holder of the FSC

stock could realistically have expected.” 150 T.C. at 166

(emphasis added). By statutory design, a FSC typically will

not be owned by an “independent” entity; it will be owned

by “a person described in section 482,” I.R.C. § 925(a)—

viz., an entity “owned or controlled directly or indirectly by

the same interests,” id. § 482 (emphasis added). As we have

explained, the tax benefits associated with the FSC regime

contemplate related entities on both sides of the FSC. See

supra at 14, 31–32. As a result, no “independent” person

would realistically be expected to obtain value from owning

13

One possible exception might be a scenario in which the FSC is

effectively used to make a gift to a third party. Cf. Benenson, 910 F.3d

at 696 n.5. We express no view on how the Code and regulations would

apply in such a distinct scenario.

MAZZEI V. CIR 33

an FSC because a foreign exporter would have no practical

incentive to choose to pour money into such a FSC. 14

For similar reasons, the Tax Court’s reliance on the

“anticipatory assignment doctrine” discussed in Banks,

543 U.S. at 434, is also flawed. That doctrine states that, as

a general matter, “gains should be taxed ‘to those who

earned them,’” so that a “taxpayer cannot exclude an

economic gain from gross income by assigning the gain in

advance to another party.” Id. at 433 (citation omitted). The

FSC regime explicitly departs from that principle as well

because the key feature of the FSC mechanism is that the

relevant income earned by the export company is instead

funneled to the FSC—which did not earn it—and it is then

taxed at the FSC level (rather than the export company level)

before then being cycled back out to a related entity. 15

Application of the anticipatory assignment doctrine here

would mean that Injector Co., rather than the FSC, should be

treated as the earner of the income, all of which was

produced by Injector Co.’s efforts. Such an outcome, of

course, is directly contrary to the scheme of the FSC statute.

The Tax Court sought to side-step this problem by

14

Moreover, in treating the Roth IRA ownership as illusory, the Tax

Court overlooked that there are real-world consequences to the fact that

the Roth IRAs own the FSC rather than Injector Co. or the Mazzeis.

Although there are certainly tax advantages to that arrangement, one

consequence of that ownership is that the moneys distributed by the FSC

to the Roth IRAs as dividends could not be withdrawn without penalty

unless and until the respective owner is eligible to make qualified

withdrawals. For a younger individual such a Celia Mazzei, that is not

an insignificant limitation.

15

As noted earlier, if the related entity that received the money on

the return trip is taxed as a corporation, then it typically pays no tax on

those dividends when they are received from the FSC. See I.R.C.

§ 245(c)(1)(A); supra at 16.

34 MAZZEI V. CIR

characterizing the FSC as the generator of the income, see

Mazzei, 150 T.C. at 161, but of course the FSC did pay tax

on its income. The court purported to treat the dividends as

the relevant income, see id., but that approach—which asks

who controls the assignment of the FSC’s dividends—

simply begs the earlier-addressed question of who owns the

FSC.

Accordingly, the Tax Court’s application of substance-

over-form principles in determining who owned the FSC in

this case rested critically on subsidiary premises that directly

conflict with the very features of the FSC regime that

explicitly depart from such principles. The court therefore

erred in invoking such principles to set aside the Roth IRAs’

formal ownership of the FSC’s shares.

2

This conclusion is reinforced by two further textual clues

in the language of the FSC statute.

First, as noted earlier, the special hypothetical valuation

formulas contained in the FSC statute are an express

exception to the allocation rules that would otherwise govern

under § 482 of the Code, and the statute thus expressly

contemplates that a FSC will ordinarily receive its funds

from “a person described in section 482,” I.R.C. § 925(a)—

viz., an entity “owned or controlled directly or indirectly by

the same interests,” id. § 482 (emphasis added). Because the

FSC statute waives the normal rules with respect to any

“person described in section 482,” the statute applies its

special rules regardless of which related entity owns it. Id.

§ 925(a). The Tax Court’s reasoning, however, effectively

rewrites this provision as if it required the export company

that funnels money into the FSC to be the one that owns it

and that therefore would receive the dividends out of it. But

MAZZEI V. CIR 35

nothing in the statute imposes such a requirement, and the

text of § 925(a) negates it.

Second, Congress is obviously aware that tax-free

entities, including IRAs, can own a FSC because the FSC

was modeled on the DISC and Congress added a provision

to specifically address that scenario only in the DISC

context. The DISC and FSC statutes use identical language

in waiving the normal allocation rules that would apply to

the DISC or FSC in a transaction with “a person described

in section 482,” and both statutes therefore contemplate that

a variety of related entities might be the holder of the DISC

or FSC stock, including tax-exempt entities like IRAs.

Compare I.R.C. § 925(a) with id. § 994(a). But as noted

earlier, Congress in 1988 enacted a special provision stating

that, if a tax-exempt entity (such as an IRA) owns shares in

a DISC, then any dividends distributed, or deemed

distributed, to the IRA are generally “treated as derived from

the conduct of an unrelated trade or business,” see id.

§ 995(g), and therefore subject to taxation under § 511. See

supra at 11. Congress, however, did not add a similar feature

to the then-existing FSC statute that would similarly tax

dividends received by a tax-exempt entity that owns shares

of a FSC. 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. See Russello v. United States, 464 U.S. 16, 23

(1983) (“Where Congress includes particular language in

one section of a statute but omits it in another section of the

same Act, it is generally presumed that Congress acts

intentionally and purposely in the disparate inclusion or

exclusion.” (simplified)). That may have been unwise, but

we cannot rewrite the Code to impose an effective ban on

36 MAZZEI V. CIR

FSC ownership by Roth IRAs, which is essentially what the

Commissioner has asked us to do here.

3

Finally, our conclusion is supported by the decisions of

the First, Second, and Sixth Circuits in three appeals arising

from a single Tax Court proceeding involving a Roth IRA

that indirectly owned shares in a DISC.

In Summa Holdings, Inc. v. Commissioner, 109 T.C.M.

(CCH) 1612, 2015 WL 3943219 (2015), James Benenson,

Jr. (“James Jr.”) and Sharen Benenson were the trustees of a

trust (the “Benenson Trust”) for which their two sons

(“James III” and Clement) were the beneficiaries. 2015 WL

3943219, at *1. The Benenson Trust, together with James

Jr., owned most of the shares of Summa Holdings, a

company whose subsidiaries had significant export sales. Id.

at *1–2. James III and Clement established Roth IRAs,

which ultimately became equal shareholders in JC Holding,

a C corporation, which in turn owned JC Export, a DISC. Id.

Through a series of agreements with Summa subsidiaries, JC

Export received commissions from those subsidiaries in

accordance with the statutory formulas applicable to DISCs.

Id. at *2. JC Export then paid out the sums it received as

dividends to JC Holding, and that company, as a C

corporation, paid corporate tax on those sums. Id. After

withholding that estimated tax, JC Holding then distributed

the remainder equally as a dividend to James III’s and

Clement’s Roth IRAs. Id. The Commissioner issued

deficiency notices to several of the taxpayers involved, and

the Tax Court ultimately relied on substance-over-form

principles in concluding that the payments made by the

Summa subsidiaries to JC Export “were not DISC

commissions but deemed dividends to Summa’s

shareholders followed by contributions to the Benenson

MAZZEI V. CIR 37

Roth IRAs.” Id. at *8. As a result, Summa’s deduction of

those commissions was disallowed; James Jr. and the

Benenson Trust were found to have failed to report these

“deemed” dividends as income; and James III and Clement

owed excise taxes on the excess contributions to their Roth

IRAs. Id. at *4, *9. These taxpayers each appealed to their

respective circuit courts—Summa to the Sixth Circuit;

James Jr. and Sharen (the trustees of the Benenson Trust) to

the Second Circuit; and James III and Clement to the First

Circuit. All three circuits ruled against the Commissioner.

None of these decisions addressed the exact question

presented here, but the First Circuit’s decision comes closest.

That court addressed the Commissioner’s claim that the

dividends received by the Benenson sons’ Roth IRAs should

be characterized as contributions in excess of the applicable

limits. Benenson v. Commissioner, 887 F.3d 511, 516–22

(1st Cir. 2018). The First Circuit distinguished the Tax

Court’s decision in the Mazzeis’ case on the grounds that, in

the Benenson case, the Commissioner had “never challenged

the valuation of the shares the Roth IRAs purchased.” Id.

at 522; see also id. at 522 n.10. But in rejecting the

Commissioner’s recharacterization of the transaction, the

First Circuit nonetheless went on to make several points that

are directly relevant to our analysis. Specifically, the First

Circuit held that, in light of the Code provisions governing

taxation of DISC dividends paid to C corporations and to

tax-exempt entities, Congress had clearly permitted such

entities to own DISCs and to receive DISC dividends. Id. at

520–21. This recognition that Congress is aware that Roth

IRAs and C corporations can own DISCs likewise applies in

the FSC context. See supra at 35–36.

Moreover, the First Circuit held that it did not matter that

the dividends ultimately received by the Roth IRAs greatly

38 MAZZEI V. CIR

exceeded any risk to the direct and indirect shareholders of

the DISC. As the court explained, the Code provisions

governing IRAs plainly allow the funds in an IRA “to grow

through investment in qualified privately held companies,

even during periods where the taxpayers are no longer

allowed to contribute, and even if such growth occurs at a

swift rate.” Benenson, 887 F.3d at 520 (emphasis added).

And in response to the Commissioner’s complaint that this

enormous return was for an investment in the DISC that

involved “no risk” to the Roth IRAs, the First Circuit noted

that this was “due to the unique, congressionally designed

DISC corporate form.” Id. at 522. The same reasoning

supports our earlier conclusion that, because a similar lack

of risk is inherent in the “unique, congressionally designed

[FSC] corporate form,” the Commissioner may not invoke

that congressionally sanctioned feature as a basis for

attacking the ownership structure of the FSC. See supra

at 29.

Although less directly relevant, the decisions of the Sixth

and Second Circuits in the Benensons’ case are also

consistent with our holding. The appeals in these two

circuits involved different taxpayers (Summa in the Sixth

Circuit and James Jr. and Sharen in the Second Circuit), but

the underlying issue in both cases was the same—viz.,

whether the commissions paid by the Summa subsidiaries to

the DISC were properly recharacterized, under the

substance-over-form doctrine, as dividends to Summa’s

shareholders. Both courts answered that question in the

negative. Underscoring the core point we have made here,

the Second Circuit held that the Commissioner’s effort to

invoke the substance-over-form doctrine to recharacterize

the commissions to the DISC ignored the fact that “Congress

has itself elevated form over substance insofar as DISC

commissions are concerned by affording exporters

MAZZEI V. CIR 39

‘commission’ deductions for payments that lack the

economic substance generally associated with

commissions.” Benenson, 910 F.3d at 700. And the Sixth

Circuit likewise noted that the Commissioner’s reliance on

the doctrine could not be reconciled with the fact that the

“Code authorizes companies to create DISCs as shell

corporations that can receive commissions and pay

dividends that have no economic substance at all.” Summa

Holdings, 848 F.3d at 786; see also id. (“By congressional

design, DISCs are all form and no substance . . . .”).

We join our sister circuits in concluding that, when

Congress expressly departs from substance-over-form

principles, the Commissioner may not invoke those

principles in a way that would directly reverse that

congressional judgment.

III

As the First Circuit noted in the Benenson case, some

might think that what the Mazzeis did here was too “clever,”

if not “unseemly.” 887 F.3d at 523. But as that court noted,

the substance-over-form doctrine “is not a smell test,” it is

“a tool of statutory interpretation.” Id. It may have been

unwise for Congress to allow taxpayers to pay reduced taxes,

and pay out dividends, “through a structure that might

otherwise run afoul of the Code.” Id. at 518. But it is not

our role to save the Commissioner from the inescapable

logical consequence of what Congress has plainly

authorized. Accordingly, to the extent that it was adverse to

the Mazzeis, the judgment of the Tax Court is reversed.

REVERSED.