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Tax Planning for Exporters: IC-DISC

IC-DISCs (Interest Charge-Domestic International Sales Corporations) provide U.S. exporters with substantial tax incentives and deferral opportunities that can create tremendous savings. At PFC, we thoroughly understand IC-DISCs, can calculate the potential benefits of setting up one, and can handle the filing requirements.

“It surprises me when I learn that so many CPAs (including those at large firms) are unaware of the most powerful tax incentives that I have encountered. The IC-DISC allows small businesses that export to transform ordinary income into dividends and be taxed at the preferential dividend tax rate (currently 15%). I have seen, first hand, savings in the millions of dollars.” Howard Flitt

Although the extraterritorial income (ETI) exclusion was repealed several years ago, exporters were left with an alternate tax savings incentive: The Interest Charge-Domestic International Sales Corporation, aka IC-DISC. With the current 15% tax rate on corporate dividends, companies that export property or provide services outside the United States should seriously consider the tax savings and advantages the IC-DISC can provide.

To determine if you can benefit from an IC-DISC structure, you must be able to answer yes to the following questions:

  • Does your company sell or lease export property or provide services that are related in or are subsidiary to any exchange of property outside the United States?
  • Is your company profitable for tax purposes?
  • Is your company closely held?

If your answer is yes to each of the questions, then your federal income tax on a portion of your export profits can be reduced and deferred significantly. To take advantage, a “paper” domestic corporation needs to be established. Details are provided later in this article.

First, one must know what constitutes export propertyAlthough exporters often think export property must be new, the export property can be used equipment, scrap metal or produce. The key is that the property must be grown, produced or extracted in the United States by an entity other than the IC-DISC. In most circumstances, the manufacturing (or operating company) owners will establish the IC-DISC for their benefit. The export property must be held for sale, lease or rental in the ordinary course of business for direct use or consumption outside the United States. Property can also satisfy this destination test if it is sold to a customer in the United States provided the property does not undergo further manufacturing prior to export and is shipped to its foreign destination within one year.

The IC-DISC Benefit

The IRS allows exporters a commission deduction (deductible against 35% income) payable to the IC-DISC. The owners of the IC-DISC will report this income as dividends (taxed at 15%) when the money is distributed. The structure allows owners the opportunity to convert regular income taxed at 35% into dividend income taxed at 15%. There are special provisions which allow for a one-year deferral of income to individual IC-DISC shareholders on income attributable to $10 million or less of export receipts.

The commission income of the IC-DISC is calculated using one of the two following methods, whichever is greater:

  • 4% of qualified export receipts or
  • 50% of combined taxable income from export sales.

An example of the calculation is as follows:

ABC Exporter
Foreign Trading Gross Receipts $10,000,000
Cost of Goods Sold $6,000,000
Selling, General and Administrative $3,000,000
Export Net Income $ 1,000,000
     Tax Paid without IC-DISC $350,000
IC-DISC Commission
     (a) 4% of Qualified Gross Receipts $400,000
     (b) 50% of Export Net Income $500,000
IC-DISC Commission (greater of a or b) $500,000
Tax Savings
     Value of the Deduction 35% of $500,000 = $175,000
     Cost of the Income 15% of $500,000 = ($75,000)
     Tax Savings with IC-DISC $100,000

The IC-DISC Structure

An IC-DISC is a corporation that basically acts as a “paper” entity. It does not require office space, employees or tangible assets but must meet the following requirements:

  • Elects to be treated as an IC-DISC and such election is in effect for the tax year. (Benefits begin once the election is made so waiting will delay your benefits)
  • Has a minimum capital of $2,500 (at par or stated value)
  • Has only one class of stock
  • Has at least 95% of qualified gross receipts and 95% of qualified assets at the close of the year. (This test is easy to satisfy)
  • Shareholders can be corporations, individuals, or a combination of both

In summary, the IC-DISC structure is the only remaining tax incentive available for exporters. Yet, it is underutilized which means that those businesses that could take advantage of these benefits are paying more tax than is necessary. The cost to implement an IC-DISC is relatively small compared to the savings our clients have experienced. If you are an exporter, it makes good business sense to determine if an IC-DISC can reduce your tax burden.

If you are interested in hearing more about this powerful tax incentive, please contact Michael R. Okenquist at 508 650-1122.

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