Last week we looked at the Basics of an IC-DISC and how they generate tax savings for companies that have their products or services delivered outside of the United States.
Today our focus is on what are the critical components of an IC-DISC and how can we maximize the benefit to the shareholders. If you missed the blog post, you could link to it here or above.
Keys to Tax Savings
The requirements for an IC-DISC are a starting point for locking in tax savings. Our discussion today will dig into the structure, commission calculation, grouping and optimization. While many companies can calculate an annual IC-DISC savings, few IC-DISC providers understand the detail on optimizing that benefit.
Building the Right Foundation
Setting up an IC-DISC and the related supplier agreement is critical to the foundation of the IC-DISC. In the event a new corporation is set up and elects IC-DISC status without the proper articles of incorporation, bylaws, and structure, the potential exists for the IRS to determine the entity does not meet the requirements of an IC-DISC and could rule the entity invalid. Should this happen after taking several years of tax savings on export transactions, the resulting reassessment of tax, interest and penalties could be significant. In addition, each IC-DISC should have a related supplier agreement that identifies how the related supplier and the IC DISC will pay sales commissions and how those commissions will be calculated. This agreement should follow the tax regulations in order to be valid.
Adding Up the Savings One Transaction at a Time
As we discussed last week, the tax savings generated by the IC DISC is a result of the sales commissions calculated from export sales and net income. The tax regulations allow these sales commissions to be calculated as the largest of 4% of export revenue, 50% of net income derived from export revenue or using a marginal cost approach derived from intercompany pricing rules found in Code Section 994. In addition, each transaction can be analyzed under the various methods to determine which will generate the largest tax benefit. After making allowable adjustments under Code Section 861, analyzing each transaction to maximize the benefit is critical to the overall calculation.
Keeping the Right Company Makes A Difference
The tax regulations allow a taxpayer the ability to group transactions along several different lines in order to maximize the sales commissions. These groupings include products, product lines, or SIC codes. In addition, a portion of export transactions for a product line can utilize one method and while other transactions within the same product line can utilize other methods such as gross receipts, 50% of net income or no loss rule.
Analyze, Group, Optimize
The analysis under the various methods can be very time-consuming but with the right software and experience can result in significant tax saving. Once a listing of all transactions has been derived, they must be analyzed under each of the various methods and different grouping configurations completed in order to determine the most advantageous method. Remember that as each transaction can stand alone, be grouped, eliminated or maximized, the overall tax saving can change. Understanding the depth of the regulations and how each can be applied is critical to successfully optimizing the tax saving.
Focusing The Approach
The tax regulations for the IC DISC are complex and as with many tax incentives, understanding them is only the first step in the process. More important to successfully generating tax saving is applying them and reporting them properly. Our team has worked with hundreds of companies both on set up and optimization of their IC DISCs. We look forward to helping you understand, apply and optimize your IC DISC to maximize tax saving.