Monday, July 6, 2015
Ic-Disc: The Export Incentive You Might Be Missing Out On
If you own a closely-held company that earns significant income from exporting U.S.‑made products or from providing engineering or architectural services on foreign construction projects, and you don’t operate your business utilizing an IC-DISC, you could very well be passing up on the sole remaining federal incentive available to U.S. exporters-specifically, a relatively low-cost method of converting ordinary income from your export/foreign business activities into qualified dividend income, taxed at favorable dividend tax rates. You could be missing out on thousands of dollars in annual tax savings. What is an IC-DISC? It stands for Interest Charge Domestic Sales Corporation, and it is the last U.S. incentive offered to companies who export products or certain services to help them compete internationally. Under current law, the incentive is available to manufacturers, producers, resellers and exporters of goods produced in the United States with an ultimate destination outside the United States. To determine if you can benefit from an IC-DISC structure, you must be able to answer yes to these questions:
- Does your company sell or lease products or provide services that are, directly or indirectly, exported outside the U.S.?
- Is your company profitable for tax purposes?
- Is your company closely held?
If you answered 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 obtain the benefit, a domestic corporation must be established and an IC-DISC election must be filed. The main tax benefit from an IC-DISC for most taxpayers stems from the rate differential between ordinary income tax rates and the qualified dividend rate, as further discussed below.
Any entity or individual can own an IC-DISC. Usually, ownership should be held by an individual or flow-through entity (an LLC, partnership, or S corporation) for the greatest tax benefit. If the exporting entity is one of these pass-through entities, the IC-DISC can even be formed as a subsidiary. Once formed, the IC-DISC enters into a commission agreement with the exporting entity, and commissions are paid based upon the export activity of the exporting entity. An IC-DISC itself is not subject to U.S. corporation tax. An IC-DISC does not need employees or assets, need not perform any services or participate in any sales to earn a commission and can be totally invisible to customers. The IC-DISC is only required to comply with certain basic requirements, including maintaining a separate set of books and records, issuing only one class of stock and maintaining at least $2,500 in capital. Under the basic structure, the commission paid to the IC-DISC is calculated based on either 50 percent of the combined taxable income from exports or 4 percent of qualified gross export receipts and can be calculated on a transaction by transaction basis using the best method for each transaction.
As a tax-exempt entity, the IC-DISC is exempt from income tax on commissions earned from the exporting entity. The exporting entity can deduct the commission expense paid to an IC-DISC, resulting in tax savings to the exporting entity. When the income from the commissions earned by the IC-DISC is distributed by the IC-DISC to its shareholders, the distributions are taxed at the qualified dividend rate. Because of the American Taxpayer Relief Act of 2012, which permanently extended federal tax rates on qualified dividends to a maximum of 20 percent (plus the 3.8 percent net investment income tax, when applicable), the tax benefit from the rate differential between ordinary income rates and the qualified dividend rate appears to be settled for the long term. Care must be taken when establishing an IC-DISC to ensure the statutes and regulations are followed and that all of the legal and tax filings are properly completed. Further, there are ongoing record keeping and documentation requirements that must be followed in order to ensure deductibility of the commissions. If your business qualifies, however, an IC-DISC can be a relatively easy and low-cost method to create permanent tax savings for your company and its owners.