IC-DISC: A Tax Break for Exporters.
Both The White House and Congress agree that a key to the United States economic recovery is strengthening the manufacturing sector and encouraging exports by providing tax incentives for small and medium business owners.
Currently, the tax code allows qualified U.S. exporters to reduce corporate taxes by as much as 20% by establishing an IC-DISC (Interest Charge — Domestic International Sales Corporation). The structure is not difficult to set up, but it must be done correctly to pass the scrutiny of the IRS.
What businesses can benefit from the IC-DISC?
This is the biggest misunderstanding by business owners, as many times they don’t believe they qualify for this incentive. There are three types of businesses that potentially qualify for the IC-DISC tax benefit:
1) A company that directly exports the goods it manufactures. What counts as a manufactured good can include: software, films and many agricultural products.
2) A company who provides architectural or engineering services that are conducted in the U.S. for a building or bridge built outside of the U.S.
3) A company that manufactures a good that is included in a product that is exported. This is probably the largest missed opportunity for businesses. The IC-DISC tax incentives are also available in a situation where a company makes a component part that is included in a good that is exported.
How is it established?
The process to establish the IC-DISC is simple but it must be done correctly. A separate tax-exempt corporate entity (the IC-DISC) is formed alongside the current export company. Sometimes several entities are created to maximize the tax benefits. The export company pays commissions to the IC-DISC entity.
This is a “paper” entity, and it is not required to perform substantial economic functions nor have employees or office space. The different entity types that can use the IC-DISC include flow-through entities (S-Corps, partnerships, LLCs, etc.) and closely held C-Corps.
What are the fiscal benefits?
Permanent tax savings start with the U.S. exporting company declaring a tax deduction on the commission it pays to the IC-DISC from its ordinary income, which is taxed at a maximum tax rate of 39.6 percent.
Federal tax law establishes the commission rate, which is based on export sales revenue (maximum $10 million in annual qualified export receipts). The commission rate, is the greater of 50% of net export income, or four% of export sales revenue. Since the IC-DISC is tax-exempt (i.e., no corporate income tax), tax is only paid on distributions to shareholders. The tax is imposed at the tax rate of 20% (2013) (i.e., the qualified dividend tax rate), not the current ordinary income tax rate (maximum) of 39.6% (2013).
The commission income is tax-deferred while held in the IC-DISC, until distributed to the shareholders. The deferral of U.S. tax on the commission income (for up to $10 million in annual export sales; i.e., qualified export receipts), can be indefinite, is only subject to a minimum interest charge (as previously referenced 0.16% (2013), on the deferred tax liability.
The ultimate tax benefits include:
- The 19.6% differential between the qualified dividend tax rates and the ordinary income tax rates;
- An income tax deduction for the exporting company, on the commission paid to the ICDISC;
- No corporate income tax for the IC-DISC;
- For U.S. exporters who operate their business via a sole proprietorship or pass- through entity (e.g., limited liability company (“LLC”), S-Corporation or limited partnership (“LLP”)), the IC-DISC benefit is the difference between the qualified dividend tax rates and the ordinary income tax rates;
- Exporters who operate their businesses via a C Corporation can benefit by using the IC-DISC to eliminate double taxation on a majority of their export income, as well as to reduce additional payroll taxes on income paid to their shareholders/officers
Creating an IC-DISC and not having the proper documentation to support it can be a costly mistake. An experienced consultant will help you gain the inside knowledge needed to navigate all the different applications and requirements.
At GBS Group we have a group of multidisciplinary consultants who have the expertise and resources to help you through all that is required for establishing and maintaining an IC-DISC. Contact us for more information about this or any other taxation topic.