In an economy where corporations are missing huge opportunities by not expanding into foreign markets, most businesses are in need of a little financial guidance as they venture out.
“Let’s face it, the current recession has significantly impacted domestic growth opportunities for United States companies,” says Robert Verzi, CPA, a tax partner at Habif, Arogeti & Wynne, LLP. “With a relatively weak dollar, one bright spot is the opportunity to tap into foreign markets where, only recently, U.S. products may have been uncompetitive.”
Smart Business spoke to Verzi about how to take advantage of tax savings available to exporters.
How can my company grow in the foreign markets?
Currently, exporters are doing quite well. A January 2008 report from the International Trade Administration showed that U.S. exports increased by 12.3 percent to $1.48 trillion from 2006. While we don’t look for robust selling opportunities in the near future, we still believe U.S. companies have the potential to increase cash flow and find some new sales through exporting.
Are there programs to help if my company is interested in exporting its products?
As a matter of fact, exporters can take advantage of an often-overlooked export tax incentive, which can reduce federal and state income on exports and help stimulate cash flow to produce more goods for export. Many companies may have heard of the Domestic International Sales Corporation (DISC), but few realize or understand its full benefit.
Specifically, if your business has either type of transaction listed below, you can convert ordinary income (taxed at about 34 or 35 percent) to capital gain income taxed at 15 percent. The following types of income qualify for this special tax benefit:
- Exported property that is manufactured in the United States
- Engineering or architectural services rendered for projects located (or proposed for location) outside the United States.
How does this work?
You will have to form a U.S. corporation and elect to be treated as a DISC, which is essentially a paper company needing very little substance. Its taxable income is computed using special pricing rules, but it does not pay U.S. income tax. A DISC can earn income in an amount equal to the greater of:
- 50 percent of the taxable income of
your export sales; or
- 4 percent of the gross receipts on the export sales.
The amount determined under the 4 percent method can’t exceed the total amount of taxable income derived from export sales. The income earned by the DISC would be subject to the 15 percent income tax when distributed to its shareholders.
Can you give me a specific example?
Let’s suppose the following:
- Company XYZ forms a DISC.
Company XYZ has $3 million of export
- Assume that the cost of goods sold relating to these sales is $1.5 million and other expenses $500,000, leaving a net export profit of $1 million.
XYZ Corporation would use the 50 percent method (described above) since this alternative would generate the most tax benefit. So, $500,000 (50 percent of $1 million) would be subject to tax at 15 percent instead of the corporate rate of 34 percent (if XYZ were a C corporation) or 35 percent if XYZ were an S corporation (assuming the shareholder is in the top marginal individual tax rate).
Assuming the latter, XYZ Corporation and its shareholders would save $100,000 by the tax rate savings alone (20 percent of $500,000) in federal income tax per year. In addition, state income taxes can be saved by using the DISC structure. The savings is unlimited. The more your business exports, the more the potential tax savings.
Taxpayers can take advantage of these substantial savings only after they form a U.S. corporation and make an election to treat the company as a DISC. If you think a DISC may be right for your company, contact your tax adviser.
ROBERT VERZI, CPA, is a tax partner at Habif, Arogeti & Wynne, LLP with more than 20 years of experience specializing in international tax solutions for publicly and privately held corporations in a variety of industries including manufacturing, technology and retail. Reach him at (404) 898-8486 or email@example.com.