Exporting goods overseas can have a positive impact on your business. The Interest Charge Domestic International Sales Corporation, or IC-DISC, can offer a tremendous tax benefit and a permanent tax savings opportunity for your company.
Generally, if you are a tax-paying entity that exports more than $1 million in sales to locations outside the U.S., you should consider an IC-DISC, says Tim Schlotterer, CPA, director, tax and business advisory services with GBQ Partners LLC. An IC-DISC could reduce your federal effective tax rate on qualified export income by as much as 20 percent.
“IC-DISC has become more prevalent in recent years due to the favorable qualified dividend tax rate,” says Schlotterer. “In years past, companies have used other export incentives. However, those are no longer available as a result of the World Trade Organization potentially placing sanctions on the U.S. for offering those incentives.”
Smart Business spoke with Schlotterer about what you need to know about IC-DISC and how it can benefit your company.
What are key items businesses need to understand about an IC-DISC?
IC-DISC is not for everyone. It is really important to identify that you have qualified export income. Three requirements must be met in order for an IC-DISC to have qualified income from an export sale.
- The goods sold must be manufactured, produced, grown, or extracted in the U.S. by an entity other than the IC-DISC.
- The export property must be held primarily for sale, lease or rental use, consumption, or disposition outside the U.S.
- The export property must contain at least 50 percent of the fair market value attributable to U.S. produced content.
In addition to export sales, an IC-DISC can be used if you are providing engineering or architectural services for construction projects located outside of the U.S.
What is an IC-DISC?
An IC-DISC is a separate legal entity. Companies will need to coordinate with their tax adviser and attorney to incorporate the IC-DISC. An IC-DISC’s benefits are not retroactive. To qualify as an IC-DISC, a corporation must:
- Have a minimum capitalization of 2,500 authorized and issued shares.
- Have a single class of stock.
- Be incorporated in one of the 50 states or in the District of Columbia.
- Have qualified export sales.
- Ninety-five percent of the IC-DISC’s gross receipts and assets must be related to the export of property.
- File an election with the IRS to receive approval to be treated as an IC-DISC for federal income tax purposes.
- Maintain separate books and records.
How can an IC-DISC reduce taxes?
An entity that has qualified as an IC-DISC will need to set up a commission agreement with your company. The company then pays a commission (which is tax deductible) to the IC-DISC.
The qualified export sale commission income earned by an IC-DISC is tax-exempt as long as the IC-DISC distributes its income to its shareholders. This distribution is made in the form of a qualified dividend, which is currently taxed at a rate of 15 percent.
There are two methods by which the commission can be computed. Companies are able to compute this commission on a transaction by transaction basis. Therefore, companies are able to use the greater of the two methods in determining which commission to charge:
- 4 percent of qualified export receipts
- 50 percent of foreign source taxable income.
It is recommended that you work with your tax adviser to determine which commission method should be used. Companies with large gross margins will generally have a larger tax benefit using the 4 percent method in computing the IC-DISC commission.
What are the benefits and risks associated with IC-DISC?
The largest benefit an IC-DISC provides is a permanent tax savings to the company. In addition to this, an IC-DISC could be used as a way to incent key employees within your organization or as an estate planning tool.
There is no requirement that an IC-DISC’s shareholders be the same as those of the company. You can therefore offer ownership that differs from the operating company and distribute earnings to the shareholders in the form of a 15 percent qualified dividend.
The largest risk of IC-DISC is that the qualified dividend rate of 15 percent is only secured through the end of 2012. There is concern that if nothing is done with the current tax law, the qualified dividend rate would go away and it would return to the ordinary tax rate, so there would be no difference in the tax rates and no benefit.
To the extent that the qualified dividend rate stays at 15 percent, or lower than the ordinary tax rate, an IC-DISC will be a good option for companies to enhance their export sales in the future.
Tim Schlotterer, CPA, is director, tax and business advisory services, at GBQ Partners LLC. Reach him at (614) 947-5296 or [email protected]
Insights Accounting & Consulting is brought to you by GBQ Partners LLC