There have been significant changes in and repeals of tax laws affecting U.S. businesses over the last 14 years. However, one export incentive that has been around since the early 70’s remains intact and is having a resurgence.
An interest-charge domestic international sales corporation (IC-DISC) can be a powerful tax-savings opportunity for many companies exporting products. The current 23.8 percent tax rate on qualified dividends, comprised of a base 20 percent tax plus 3.8 percent net investment income tax (NIIT), makes the IC-DISC worth looking into.
If you haven’t looked into it before, or it’s been awhile, now is the time to take another look at it. Your business may have changed, maybe there are new decision makers involved, maybe your exports are up, or maybe the reasons for not going forward before no longer exist.
Here are the basics. A U.S.-based exporter is allowed a deduction for the commission paid to an IC-DISC at the exporter’s ordinary tax rate. The shareholders of the IC-DISC are taxed on the resulting dividend at the 20 percent rate, usually with an additional 3.8 percent NIIT. Assuming a maximum 39.6 percent individual tax rate on income from flow-through entities such as LLCs and S corporations, the tax savings can reach almost 16 percentage points.
The IC-DISC, in most cases, is a paper entity, a U.S. corporation that is paid a commission by the related supplier—the exporter—on its export sales. Keep in mind, this is an export incentive that was enacted by Congress to stimulate exports. It’s not a tax shelter, and it’s been around for over forty years.
The commission paid to an IC-DISC is generally the greater of 50 percent of the net profits, or four percent of the gross receipts, but not more than 100 percent of the net profits, on exports of products that are manufactured, grown, or extracted in the United States.
The products must be manufactured, grown, or extracted in the United States by an entity other than the IC-DISC. The products must be held primarily for sale, lease, or rental for direct use, consumption or disposition outside the United States. Up to 50 percent of the fair market value of the export property can be attributable to foreign content.
An IC-DISC must also be a domestic corporation; have at least $2,500 in capital; have only a single class of stock; file a timely election to be treated as an IC-DISC; and must meet a 95 percent qualified export asset test and a 95 percent qualified gross receipts test.
An IC-DISC is not subject to U.S. income tax. It is more like a partnership, LLC, or S corporation in that its shareholders are subject to U.S. income tax on their share of the IC-DISC’s income. The exporter, its shareholders, its management, its employees, family members or any combination thereof can own the IC-DISC. For example, the IC-DISC can be used to generate incentive bonuses for management or employees, or facilitate succession planning. Alternatively, the funds accumulated in the IC-DISC can be distributed to the shareholders and loaned or contributed back to the exporter if the cash is needed.
The IC-DISC regime is the one remaining U.S. export incentive and provides U.S.-based exporters an opportunity to decrease their U.S. taxes on export profits by almost 16 percentage points. It’s worth considering, or reconsidering, as the case may be.
Max A. Koss, CPA, is the Director of International Tax at Warren Averett CPAs and Advisors and is based in the firm’s Birmingham, Ala. office. He may be contacted at firstname.lastname@example.org. Kevin C. Lucier, CPA, is a Member in the firm’s Atlanta office, and may be contacted at email@example.com.