One of the most interesting components of an IC-DISC is the calculation of IC-DISC income and the commission expense to the related operating company.
Because in general, it appears simple but when applying the rules that will truly optimize the tax benefit, it is a much more complicated calculation. Let’s take a look:
What are the methods of calculating commission income?
The simple calculation utilizes the greater of two methods:
- 4% of gross receipts
- 50% of combined taxable income
While this seems like a simple enough task (and a number of my clients will use this as a benchmark to estimate a low-end of the potential benefit), it ultimately will not generate the largest benefit available to the taxpayer in most circumstances. Check out our free IC-DISC Calculator to find your estimated commissions.
A loaded question at best…
The Internal Revenue Code and regulations relating to an IC-DISC allow a taxpayer the allocation of costs and expenses between export and domestic transactions.
In addition, types of transactions can be grouped in a variety of ways to maximize the profit margin. By completing an allocation of costs either ratable or directly to product types or transactions, a taxpayer can increase the profit per group (or transaction) and as a result increase the commission paid to the IC- DISC.
Grouping of transactions (Reg Section 1.994-1(c)(7)
Taxpayers can make an annual determination to group their transactions by product or product-line so long as the grouping conforms to (a) a recognized industry or trade usage, or (b) the 2-digit major groups of SIC codes (or inferior classifications or combinations).
The grouping of transactions does not limit the taxpayer to using a product-line grouping as well as a transaction-by-transaction method for another product.
It should also be noted that profits generated under any of the methods are limited to the overall profit percentage (also known as OPP) of the operating entity. So, if a taxpayer generates a loss for the tax year, they may not generate a tax benefit using an IC-DISC for that tax year.
Part of a consultant’s role in working with a company that exports products or services is to evaluate the various ways to group products in order to maximize the potential benefit. In some cases, the resulting optimization analysis can increase the benefit to the taxpayer by as much as 45-50% over the gross receipts (4%) or CTI method (50%).
In our next article on IC DISC Basics
Next week we will take a look at expense allocation under 1.861-8 to understand some of the overriding concepts that are critical to optimizing IC-DISC tax benefits. We hope you will stay tuned.
What say you my friends?
Are you truly optimizing your IC-DISC benefit through product grouping and T by T analysis?
Has your product mix changed in the last few years?
Are you looking properly at allocating expenses under 1.861-8?
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Randy Eickhoff, CPA is President of Acena Consulting. With more than 20 years of tax and consulting experience, Randy focused on helping companies successfully document and secure tax incentives throughout the US. He has been a long-time speaker nationally as well as conducted numerous training sessions on R&D tax credits and other US tax incentives.