Annual Permanent Tax Savings for Exporters: The IC-DIS
Does your company export U.S. produced goods? Do distributors export your company's U.S. produced goods? If you answered yes to either of these two questions and your U.S. Company is privately held, you should be enjoying sustainable year-to-year, permanent tax savings on export sales.
Tax law changes have hurt U.S. exporters by phasing out tax benefits available through incentives such as the "extraterritorial income exclusion" (EIE). Fortunately however, there is still a way to offset the loss of prior tax incentives. It is based on a tax device that's been on the books since 1984 called the Interest Charge Domestic International Sales Corporation -- or IC-DISC, for short. Previously the IC-DISC received scant attention in the business world. But now it's in the spotlight. Best of all, the benefits of the IC-DISC arrangement are available to a wide range of business entities, including limited liability companies (LLCs), closely held C corporations, S corporations and partnerships.
How it Works
The owners of an export company form a new business entity and elect to treat it as an IC- DISC for federal income tax purposes. The IC-DISC is a tax-exempt domestic "paper" corporation that is fully approved by the IRS. Frequently, the IC-DISC will have the same ownership structure as the export company. However, the ownership may be different as well.
After formation of the IC-DISC, the export company enters into an agreement to pay the IC-DISC commissions based on qualified export sales. The commission may be determined under one of several methods approved by IRS regulations. Two common approaches are:
- A commission equal to 4 percent of the qualified export sales or
- A commission equal to 50 percent of the taxable net income from the qualified export sales.
The commissions paid are deductible by the export company against income that is taxed at rates up to 40.5 percent while the commission income received by the IC-DISC is exempt from tax. When the IC-DISC pays out (in the form of dividends) the commission income it received, the dividends are taxed to the IC-DISC owner at a maximum rate of 23.8 percent (a 20 percent dividend rate plus an additional 3.8 percent medical contribution tax related to the Affordable Care Act). Thus by utilizing an IC-DISC, tax savings are realized by converting export income, which is taxable at these ordinary income rates of 40.5 percent, into qualified dividends taxed at 23.8 percent (Exhibit 1).
The IC-DISC does not have any substantive impact on the operations of the export company. It is not required to hire employees, have operations, hold inventory or other assets or perform any specific functions. However it must have its own bank account, keep separate accounting records and file U.S. tax returns.
Distributors, software developers, manufacturers, agricultural exporters and natural resource exporters can qualify for benefits on export sales. In fact, distributors and other companies can claim an IC-DISC benefit on the same export products. However, the distributor must share copies of its bills of lading with the other companies. In certain cases, the distributor cannot materially alter the products after completion.
The IC-DISC is a complex area of the tax law. This is only a brief overview of the IC-DISC arrangement under federal income tax law, and state tax must also be considered. The experts at Clarke, Snow & Riley, LLP can assist you to easily navigate the process. To determine if your company might benefit from an IC-DISC, please contact Clarke, Snow & Riley, LLP.
For more information, contact Greg King at MassMEP, firstname.lastname@example.org