Politics and grandstanding aside, the election continues to heat up and with it come the promises, predictions and pandering to various groups of taxpayers. One area where each the candidate takes a stand is on the tax rate on qualified dividends.
Republican candidates would retain a lower rate of roughly 12% - 15% while President Obama’s plan, would provide a lower rate for taxpayers making less than $200,000 per year ($250,000 for married couples) and tax-qualified dividends at ordinary income rates for those over the $200,000 threshold.
At the same time, President Obama was clear in his State of the Union address that the US wants to support manufacturing and provide incentives to increase exports.
Perhaps, I am naïve but these two statements don’t make sense when the last remaining export incentive is based largely on the lower qualified dividend rate.
Let’s take a look:
Lower Qualified Dividend Rates equal export tax incentive
As we have discussed in a prior blog posting, the IC-DISC is a tax incentive available to US companies that deliver products and services (some services) outside the US (including Canada and Mexico). The benefit is largely based on the ability of a company to pay a sales commission on international sales (export sales) to an IC-DISC and receive a current year deduction at their marginal tax rate. Once the sales commission is paid to the IC-DISC, it is then paid to the shareholders of the IC-DISC as a qualified dividend.
When the dividend rate is lower than the ordinary income tax rate, a permanent tax savings is realized by the shareholders of the IC-DISC (who are typically the owners of the company exporting products and services or the IC-DISC is owed directly by the manufacturing company). Remember we are gaining a deduction at ordinary income rates and then paying tax on the dividend payment to the shareholders at a lower tax rate.
Today, that benefit is roughly a 20% tax savings.
When The Qualified Dividend Rate equals ordinary income rates
What happens when ordinary income rates are equal to qualified dividend rates?
An IC-DISC can still receive sales commissions by that generate a current year deduction for the manufacturing company. However, if the IC-DISC then pays the shareholders a dividend, they would be taxed at the same rate and realize no tax benefit. Under President Obama’s plan, this would likely be the result for most business owners that deliver products outside the US.
The other option would be to leave the sales commissions in the IC-DISC and pay a small interest charge (at the T-bill rate). The US company would receive a current year tax deduction, and shareholders would not pay a tax on the dividend until it was paid from the IC-DISC.
This would still create a small benefit because the sales commissions that can be kept in the IC-DISC are limited to the commissions calculated on $10 million of international sales. For small and medium sized businesses that sell extensively outside the US, this approach would NOT be beneficial or support their efforts to export products and services as the President committed to doing in his State of the Union speech.
Do Congress and the White House Understand?
It seems this connection between the lower dividend rate and export sales wasn’t considered when the President and his team of “experts” put together their plan to support US manufacturing. I wonder if they realize that the companies that will make a difference in terms of new jobs and increasing exports are the small and medium-sized businesses in the US.
Many of these businesses have and use an IC-DISC and (as you might expect) because of their innovation and success, the owners make more than $200,000 per year.
Are we now going to sacrifice supporting US manufacturing companies in order to make everyone pay their fair share?
How many jobs might it cost US taxpayers because these US manufacturing companies are NOT getting support in their efforts to export?
What say you my friends?
Are you currently exporting your products and taking advantage of an IC-DISC?
How much additional tax would you pay if dividend rates were the same as ordinary income rates?
Do you believe Congress and the White House are aware of this issue?
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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.