I spend a fair amount of time educating business owners and CPAs on various tax savings opportunities that are available through tax incentives. It is not uncommon for us to get introduced to a company that is not only successful but is designing and building products that are then delivered outside the US.
Typically, our first questions relate to what are they designing and will they potentially qualify for a research tax credit. The second round of questions turn to their exports and how and what they are exporting. By the time we get to give information, we have identified a six figure tax savings that will provide the business with additional working capital to grow even faster.
IC DISC – The Last Man Standing
When the discussion turns to exports, some people are familiar with Foreign Sales Corporations (FSCs), the now defunct Extra Territorial Income Exclusion (ETI or EIE) or other tax vehicles that have all been deemed “unfair” by the World Trade Commission. The last remaining export incentive that has survived the crucible of the WTO is the IC DISC (Interest Charged Domestic International Sales Corporation).
This one incentive can provide dramatic and critical tax savings to business owners that export their products and services abroad (including Mexico and Canada).
What’s An IC DISC?
An IC DISC is a Subchapter C Corporation that elects IC DISC status (which makes it non-taxable). This entity is a US company and acts as a commission agent for a related supplier. A commission is paid by the related supplier to the IC DISC (based on export sales and/or profits) generating a sales commission at the supplier level (as a normal business expense reducing taxable income at 35% tax rate).
The IC DISC holds one class of stock with a par value of at least $2,500 and must meet a few other reasonable easy requirements (See our IC DISC Basics slides for more information).
What’s The Big Deal?
The sales commission paid to the IC DISC is paid out as a qualified dividend to the IC DISC owners (typically the same owners as the related supplier). This qualified dividend is taxed at 15% dividend tax rate rather than the 35% ordinary income tax rate. The 20% tax savings results from the 35% sales commission deduction (at the supplier level) and the 15% dividend tax rate (at the IC DISC level). Depending on the amount of export sales and profit margin, the savings can be significant.
Measuring or Calculating the Sales Commission
Without going into the detail that this component truly deserves, there are some basic rough calculations that can be done to ballpark potential savings. The sales commission is calculated either as 4% of export revenue or 50% of net export income. This calculation can be done quickly and easily to estimate potential savings.
However, the tax regulations allow certain adjustments to net income (called Section 861 adjustments) and allow the analysis of each transaction under the two methods above.
Also, the tax regulations allow the grouping of similar transactions in various ways to maximize the sales commission and thereby maximize the benefit. Optimizing the benefit available can increase the annual tax savings by 25% to 50% depending on the company and their individual tax situation.
Who Can Benefit?
Privately-held (including foreign-owned US based) US manufacturers and distributors that sell goods manufactured, produced, grown or extracted in the US and sold in a foreign market.
Additionally, architecture and engineering firms who work on infrastructure or real estate projects abroad will qualify.
How Do You Get Started?
You already have by reading this blog on the Basics of an IC DISC. The next step is to understand if your activities and exports will qualify for IC DISC treatment and estimate the benefit available. Below is a link to additional information on IC DISCs as well as our contact information. Our team provides a complimentary analysis and review of your exports and can answer your questions related to setting up and optimizing an IC DISC. We work in tandem with your CPA firm to make sure you benefit from this opportunity.