Companies using the Interest-Charge Domestic International Sales Corporation (IC-DISC) provisions of the tax code, which are intended to help U.S. companies compete internationally, already know that the incentive essentially reduces the top federal tax rate on certain income from qualified goods and services from 39.6 to 20 percent.
“What you may not realize is that the intended and allowable available savings are often much, much greater,” says Amit Mathur, CPA, director at WTP Advisors.
Rob MacKinlay, president of Cohen & Company, says, “Many companies use basic, aggregate IC-DISC calculation methods, though other allowable methods explicitly encouraged in the regulations yield a much higher result. This can be the equivalent of claiming a standard deduction on your individual tax return when itemized deductions are much higher. Many of our clients have dramatically increased savings with a transactional analysis.”
Smart Business spoke with Mathur and his industry peers about IC-DISC and how business owners can extract more value from its proper implementation.
How can IC-DISC savings be maximized?
Most companies utilizing the IC-DISC enjoy the reduced tax arbitrage for either 4 percent of their qualified export gross sales, which is limited to the taxable income from those sales, or 50 percent of the taxable income from qualified export sales. Many believe that these are the maximum amounts used to determine the IC-DISC commission, which is subject to a top rate of 20 percent, rather than 39.6 percent. In reality, these amounts should be considered the minimum commission that results from the two simplest, basic methods.
Truly maximizing the intended and allowable benefits from the IC-DISC requires a more in-depth calculation, but may not take much more time. Each transaction can utilize a choice of many other attractive methods explicitly defined and encouraged in the regulations. For instance, transactions that yield a loss can generate commission. Transactions for products with less-than-average profitability compared with their product group or line also may yield additional benefits.
An analysis utilizing the most beneficial of these methods for different transactions will yield higher results, often more than double, compared with using the basic methods at an aggregate level.
Steve Switaj, CFO of Three D Metals, a company that has used transactional analysis in conjunction with the IC-DISC for years, says, ‘While fluctuation in material prices and unforeseen costs are constant concerns, the increased IC-DISC savings that often results from such variability is a nice feature of the incentive, and enables us to compete in export markets more effectively.’
Can prior year IC-DISC savings be improved?
Re-determinations of IC-DISC benefits can be performed for any open tax years. As Jim Bowen, tax partner at Bober, Markey, Fedorovich & Company, puts it, ‘If the savings from a transactional analysis of IC-DISC benefits is significant, amending the results should be considered, particularly for companies under audit for given tax years.’
Are you overlooking the IC-DISC entirely?
Closely held manufacturers, distributors, growers, software producers, equipment leasing companies, and architectural or engineering firms should consider it.
Mark Klimek, head of the tax practice at McDonald Hopkins, LLC, says, ‘Manufacturers and distributors not fully exploring this incentive may be missing significant tax benefits from a relatively inexpensive to implement government incentive that does not disrupt business operations.’
If products and services are ultimately used outside of the U.S., they will typically qualify. The rules for component parts ultimately sent outside of the U.S. are even more generous — generally, they can even return to the U.S. after being incorporated into another product. Tod Wagner, of Libman Goldstine Kopperman & Wolf, says, ‘Because of the favorable rules defining qualified export property, many companies eligible to use an IC-DISC are overlooking the incentive entirely as they do not think of themselves as manufacturers or exporters. In reality, they may need not to be either.’
Amit Mathur, CPA, is a director at WTP Advisors. Reach him at (216) 292-6732 or email@example.com.
Ready for a complimentary analysis of whether your IC-DISC benefits can be increased? Call Amit Mathur at (216) 292-6732.
Insights Tax Incentives is brought to you by WTP Advisors
The number of small businesses is increasing, and as owners focus on growing their companies, many are overlooking available tax incentives.
“Capital is so important to a growing company to facilitate growth and ensure stability,” says Jeremiah E. Thomas, an associate with Kegler, Brown, Hill & Ritter. “However, small business owners often get focused on running their business and miss out on opportunities to qualify for programs that can ease tax burdens and reduce capital restrictions.”
He says it’s important to know what’s available so that you can maximize your access to money for the benefit of your business.
Smart Business spoke with Thomas about how to uncover government programs that can help ease your company’s tax burden.
Are funds readily available to small businesses?
There are many programs and incentives available, but some can be hard to obtain. While businesses may have the impression that there are easily accessible grants available, many of them are designed for very specific purposes and the average startup likely wouldn’t qualify. However, that doesn’t mean there aren’t other opportunities to lower costs through tax credits and intelligent tax planning on the federal, state and local levels.
What types of tax incentives are available for a new business?
The most easily available tax incentives may be federal tax incentives because, in many instances, they are automatic. Knowing which federal incentives you qualify for and accounting for them on your annual tax return allows you to access ‘easy’ money.
For example, there is relief on capital gains taxes if you own qualified small business stock. There is also the ability to immediately deduct from taxable income certain expenses for starting a business, and small businesses are able to use tax credits for providing health care, energy efficiency improvements, and research and development expenditures.
In contrast, a lot of state and municipal tax programs require some negotiation, for instance, with county representatives to get an abatement for real estate taxes. These credits are valuable, but they take extra steps and costs to receive the benefits.
How are some tax incentives ‘automatic’?
Receiving the benefits of a tax credit can be as simple as knowing the credit exists, factually qualifying for it and checking the appropriate box on your return to get the benefit — there’s no application process.
Also, some of the existing tax software can help automatically identify tax benefits by asking questions to determine if you qualify. However, squeezing every benefit out of a particular tax incentive is more complicated than reading the form. Consulting with attorneys and accountants is a great way to identify the applicable credits, especially with more complex ones.
Are there other incentives that are more valuable or more easily accessed?
Well, there are certainly other programs. There are Small Business Administration loans, with which businesses can take advantage of lower rates to borrow capital to grow, but those programs are pretty complex and take time to apply and qualify for. At the state level, another more complex option is the Technology Investment Tax Credit Program, which provides investors with a tax credit for the money they invest in technology companies. Small companies advertise to investors the ability to get 25 percent of their investment back from the state in the form of a credit. But in order for it to benefit the company, they have to find an investor and understand the credit. Then the investor has to apply and the company has to qualify to receive the benefit, so there are many moving parts.
The state also provides some loan programs and tax credits based on job creation. The state may lay out a number of milestones during negotiation that a company must reach for it to receive a tax credit or qualify for low rate loans.
Are there options for more mature businesses?
On the federal level, large and small companies can both benefit from good structural planning. However, there are certain federal tax incentives that are only available to small businesses, which can be outgrown.
At the state level, broadly speaking, it’s easier for a more mature business to take advantage of the tax programs that exist, as Ohio is more interested in backing companies that can create more jobs, while startup companies might only be looking to hire one or two employees and may need to rely on a narrower band of incentives, such as those focused on technology.
What is the key to finding incentives that work for your business?
The real key is thinking holistically. A business is subject to different taxes. The property you own is subject to real estate tax, but programs such as the Enterprise Zone Abatement Program allow municipalities to establish local development areas where qualified companies can locate and take advantage of real estate tax abatements. There are also a number of ways companies can minimize their sales tax responsibilities, such as Ohio’s research and development sales tax exemption.
It is important to think creatively about the sources of tax and have good advisers on the accounting and legal side to keep you apprised of changes in the law. You can also talk with your local development entities to uncover state and local incentives; these programs are great marketing tools for governments to show how successful small businesses are performing in their area.
Jeremiah E. Thomas is an associate with Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5447 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Kegler, Brown, Hill & Ritter Co., LPA
When Gary Duncanson decided to move his company to a new location, he carefully considered several options.
But ultimately, the President and CEO of No Magic Inc. settled on a space in One Allen Center in Allen, Texas, for the headquarters of his company, a leading global provider of integrated modeling, simulation and analysis solutions and services.
“I really love this area because it has so much to offer,” says Duncanson. “Then I started talking to various cities in the region about location options. It was quite the battle as to where to go, but when I totaled everything up, Allen and this location came up as No. 1.”
Smart Business spoke with Duncanson about finding the right location for your business and the things you need to consider when making a move.
What prompted your decision to move your business?
We were busting at the seams and needed a new space. It was inevitable that somewhere down the line in the next year or so, we would have to move. However, what really topped it off was that, at our previous location, we had gotten all the bandwidth that we could potentially get and we needed to go somewhere where the infrastructure was newer and better.
We are a high-tech company and we live and die by our Internet presence and Internet speed. This location had the infrastructure to support our needs, so it was really a logical choice. There are so many high-tech companies moving to this area. Dallas is already the new computer gaming capital.
How can a local economic development board help a company moving into a new location?
Working with an economic development staff and board can make the process go much more smoothly. In our case, the Allen Economic Development Board jumped through hoops to help us like you would not believe. This was truly receiving the red carpet treatment. Everyone involved worked to get us in and up and running as quickly as possible, including my broker, Mark Five Commercial; our new landlord, Duke Realty; Allen Economic Development Corporation (AEDC); our city of Allen inspectors and administrators; and our service providers. They pulled off the almost impossible in a really short time frame. Once I decided to move, I wanted to do it as soon as possible, by the end of the month. It took a little bit longer than that to get through the incentives and abatements the board offered, but everything was done in 45 days.
Also, a strong economic development board can help you make connections. In our case, the board not only helped us get into the right facility, but even before we were in the facility, board members were already making introductions for us to other companies and really helping our business. In this day and age, that is critical. Having someone bring new customers to our realm was very helpful.
What else should a company consider when looking for a new location?
Incentives and abatements definitely don’t hurt. If a business can get some incentives, it can turn around and help create more jobs in the community.
Second, don’t lock yourself into a space that you will outgrow in a year or two.
We moved into more space than we need right now because we are growing rapidly and have the capacity to accommodate three times the number of employees that we moved in with.
Also look for amenities such as easy access to transportation. Affordability of homes, good schools to attract employees from other locations and proximity to restaurants, shops and entertainment are also things to consider.
You should also look for a place that is conducive to business, where your business is going to be supported. Make sure that the city, county and state are going to support business growth, not hinder it.
Also consider your employees. Are they going to be happy with where you are moving to, and will they be willing to go with you? Are there universities nearby where employees can continue their education and from which you can draw a pool of talent? Finally, make sure it is a safe area with a low crime rate that employees will be comfortable in.
What are the benefits of locating in Texas?
When I left California, I wanted to move to a state with zero income tax and, for the business, a state with a low corporate income tax, both of which I found here in Texas.
Also, this area is growing like mad, and people are still building homes. The housing market didn’t spike here like it did in other locations, so it hasn’t gone down like crazy, either.
The location is in the middle of the country, affording opportunities to easily do business on both coasts and in Europe. We’re only 30 minutes from Dallas and, even in rush hour, it’s less than an hour to the airport. There’s a cultural center, concerts at the events center, ballparks, and it’s a great place to raise a family.
I would encourage any company looking to make a move to consider this area. With a low corporate income tax, a good business environment and an excellent place for people, it is the ideal location. A huge university system puts out a lot of top talent, and there are so many places to extend your education that it’s good for the entire work force.
Gary Duncanson is President and CEO of No Magic Inc. Reach him at (214) 291-9100.
Insights Economic Development is brought to you by the Allen Economic Development Corporation, strategically positioned in the Dallas/Fort Worth metro.
It’s no secret that some states are considered to be friendlier business environments than others. But are the advantages really worth uprooting your business’s headquarters and moving to take advantage of some of the tax, work force or cultural benefits?
Smart Business talked with William C. Lucia, CEO and president of HMS Holdings Corp., a company that provides coordination of benefits and program integrity services for health care payors, about his company’s decision to relocate.
HMS announced in July of last year that it was moving its corporate headquarters from New York City to Irving, Texas. What was the primary factor that drove your decision to relocate?
HMS has more than doubled its revenue since 2007 and we required a location that could support this rapid growth. In considering a move of our HMS, Inc. corporate headquarters, we had to determine both short- and long-term cost savings as well as other aspects related to the business climate in a chosen destination. HMS looked at all the different costs involved in running our business over a long period of time and we also factored in things like cost of living, all the different kinds of state and local credits, and money available for training and for building infrastructure. In that respect, and in many other areas of consideration, North Texas and Irving in particular stood apart.
What other factors were weighed in addition to the cost of doing business for HMS as you explored whether to relocate?
We looked at a number of factors that were critical to us. Chief among them were location and accessibility, a pro-business city, work force availability and quality of life. For our company, a location centrally located to serve our national client base with ease of travel from an outstanding international airport was very important. Of course, a company is only as good as its employees and with our rapid growth, we absolutely had to have access to a large skilled labor pool and a very high quality of life that would help our company recruit and retain a strong work force. We were very fortunate to find a pro-business city as well, with a Chamber of Commerce that has been a great resource in guiding us and helping us navigate everything from site selection to securing valuable incentives to the permit process.
Can you talk a little more about what makes a city pro-business?
Absolutely. It was important to us to have our headquarters in a pro-business city that is already home to a number of Fortune 500 global headquarters. We don’t underestimate the importance of a business-focused culture in a city that has the social maturity to assimilate corporate executives into the mainstream of the community and its social circles with opportunities to serve as advocates for economic development. From an infrastructure standpoint, Irving has among the lowest municipal property tax rates in the Dallas/Fort Worth Metroplex. And for qualifying new, relocating and expanding companies, the City of Irving offers incentives that can reduce property taxes by 30 percent or more for up to 10 years. To further support qualifying businesses, the city often takes a creative approach to structuring abatements. Incentive agreements can even be structured to allow a higher percentage of benefits early in the abatement period to offset moving and start-up costs. Those are the kinds of things that set Irving apart as being pro-business.
Was HMS able to take advantage of some incentives?
Yes, the state is investing $1.6 million through the Texas Enterprise Fund in our company to help us create 350 new jobs and generate an estimated $17.6 million in capital investment. To have that kind of support from the state as well as the City of Irving was obviously a huge factor in our decision. And the State of Texas is pro-business, exhibited by the significant job growth compared to other states, and is a great location to run a rapidly growing business.
How did your employees respond to the announcement?
We already had a major center in Irving with 500 employees so we had been moving in this direction for a while. It didn’t come as a shock to anyone, but our employees responded with all the questions you might expect: Where will I live? Where will my kids go to school? What can I do for fun when I’m not working? What kind of cultural opportunities are there? Being in Irving, in the heart of Dallas-Fort Worth, we have many great education and housing options as well as entertainment and cultural activities. So our move was overwhelmingly viewed as a positive development by our employees.
What advice would you give a company considering relocating?
My advice is to follow a structured process where you closely examine your company’s overall strategy and the needs of the headquarters operation. List the issues that exist at the current city and identify the opportunities and benefits from being in an ideal location. If at the end of the day it makes sense, don’t be afraid to go for it! HMS is one of many companies that have engaged in a headquarters relocation that has infused new energy, improved market positioning and driven growth and revenue. It’s a challenging initiative, but with a well-structured process, an effective plan and a committed team, the payout can be extremely high.
William C. Lucia is CEO and president of HMS Holdings Corp., which provides coordination of benefits and program integrity services for health care payors. He has more than 20 years of experience in health care reimbursement, information systems and large-scale insurance administration.
For U.S. companies considering export sales, the potential incremental transportation costs, selling expenses, duties and other costs can create a financial barrier to entry. This complicates a tough environment in which manufacturers are working to cut costs and go lean to compete in a difficult global economy.
The potential silver bullet is an export incentive that could save you as much as 10 cents of tax on every dollar of export profit. The Interest Charge Domestic International Sales Corporation (IC-DISC) tax incentive has been in place since the 1970s but has been underutilized. However, taking advantage of this tax incentive can change your financial picture and help you compete in today’s world market.
“Businesses that implement an IC-DISC can reduce the U.S. tax cost for export sales profits by more than 50 percent,” says Doug Eckert, member and international tax practice leader, Brown Smith Wallace LLC, St. Louis, Mo. “It is an opportunity to save tax dollars on export sales so companies can reinvest that money back into their operations. This incentive is designed to encourage U.S. businesses to manufacture in the U.S. and export, with the hope that export sales on an after-tax basis will be at least as profitable as domestic sales.”
Smart Business spoke with Eckert about how IC-DISC can benefit your company and how you can qualify for the export incentive.
What is the IC-DISC tax incentive, and how does a company qualify?
The IC-DISC incentive permits qualifying U.S. taxpayers to exclude at least 50 percent, and often more, of their export income. Any company that manufactures, produces or grows products in the U.S. can qualify for IC-DISC benefits, as long as those products are exported.
Basically, you qualify if your products or goods are produced in the United States and contain at least 50 percent U.S. content — meaning that goods can contain some foreign components — and if you are selling to a customer outside the United States. The customs duty value of imported components must be less than half of the sales price of the finished exported goods.
Also, you don’t have to be the actual exporter to qualify for IC-DISC. You can still qualify if you sell goods to a customer for use outside the United States.
In addition, distributors that don’t actually manufacture goods can qualify for an IC-DISC as long as the product is manufactured in the U.S. and they export the products.
How does the tax incentive work?
To take advantage of IC-DISC benefits, you set up a separate corporation that elects to be an IC-DISC. Generally, this company would not have employees or operations.
A portion of the export profits are allocated to the IC-DISC company. There are several different allocation rules, of which, 50 percent of the export profits is the most common method. However, it is allowable to use 4 percent of gross receipts, or a method called the marginal costing method, which allows averaging of domestic sales profits and export sales profits to determine the profit that may be allocated to the IC-DISC. Taxpayers may choose the method that allocates the maximum profit to the IC-DISC.
The profit allocated to the IC-DISC is not subject to U.S. federal tax. The remaining profit stays with the exporting company.
For example, say your company makes $2 million in export profits. The IC-DISC will report receiving $1 million in export commission income, and your company will reduce its $2 million of export profits by a deduction payable to the IC-DISC, leaving only $1 million of income subject to tax.
Your company then pays tax of $350,000 (a 35 percent rate) and the DISC does not pay tax. At the time the DISC distributes its profits to individual shareholders, the distribution is taxed at the qualified dividend rate of 15 percent.
Therefore, the profits in the IC-DISC are ultimately subject to tax of $150,000 in this example, compared to a tax of $350,000 had the IC-DISC not been in place, a savings of $200,000. That amounts to a savings of 10 cents for every dollar of export profits by starting an IC-DISC and taking advantage of this tax incentive.
Can service companies qualify for the incentive?
There are carve-outs for specific industries such as software that some people may not define as a product. Also, service companies providing architectural or engineering services for construction projects outside the U.S. may qualify for an IC-DISC.
These provisions are very specific, so service firms should talk to an international tax adviser about whether they qualify.
What steps should a company pursue to take advantage of the incentive?
Talk to a tax professional who is well versed in international affairs so you can be assured that you are setting up the IC-DISC properly and realizing its full tax advantage. Essentially, to receive IC-DISC benefits, you must set up an IC-DISC corporation that is separate from the manufacturing company. The IC-DISC must be a newly formed C corporation. You then elect to be treated as an IC-DISC within 90 days, which makes the entity nontaxable for federal tax purposes.
How can implementing an IC-DISC fit into a company’s bigger tax picture?
For companies with export income, this is an opportunity to defer taxation or take advantage of lower dividend tax rates that are set to expire Dec. 31, 2012.
To ensure that the IC-DISC company is properly structured, you should work with a CPA firm with IC-DISC specialists who can guide you through the process, including all the structuring and compliance issues.
Doug Eckert is a member and the international tax practice leader at Brown Smith Wallace in St. Louis, Mo. Reach him at (314) 983-1268 or email@example.com.
Many businesses fail to take a tax credit for their research efforts because meeting the criteria set by the IRS can be daunting. But businesses that fail to do so may be missing out on what could be a significant tax savings, says John Carey, CPA, JD, an associate director for the tax department at SS&G.
“The Small Business Jobs Act expanded the carryback period for many business tax credits arising in 2010 and beyond, including the research credit, from two to five years for eligible small businesses,” says Carey. “These are privately held companies with revenue under $50 million, many of which were profitable in the years before the recession. The longer carryback period opens up some of those years, and taxes paid then can be recovered by carrying back credits generated currently. That can be a huge boost to cash flow.”
Smart Business spoke with Carey about how to make the most of the tax credit for increasing research activities.
What is the credit for increasing research activities?
The credit, commonly referred to as the research and development tax credit, is a tax incentive designed to encourage businesses to take the risk of putting their resources into research to develop new products and technologies. That research must take place in the United States and has to meet four criteria. It has to involve technical uncertainty — it’s not a sure thing that you will be able to accomplish this, so there is an element of risk; there has to be an attempt to develop a new product or process, or to improve the functionality of an existing product or process; it has to be done through the process of experimentation, by trial and error; and it has to be technological in nature.
What barriers do businesses face with this credit?
Many companies, especially smaller ones, have faced a number of obstacles and have either shied away from taking the credit completely, or have failed to maximize its benefits. For one thing, there has been a great deal of uncertainty surrounding the credit, which has been set to expire a number of times. The provision of the law providing for the credit has been extended for only one year at a time, and more than once the extension has come at the last minute. This has made it hard to plan for using the credit. But the current administration favors making the credit permanent.
The calculation of the credit involves comparing current data to data from a base period, which is set at 1984 to 1988. A company that has been around since that time has to compare what it is doing today with what it did back then. It has to collect data from that period, including W-2 forms, documented detail of which employees did what and how much time was spent on research, and documentation of expenditures for supplies, computer usage and contracted services.
There is also an alternative simplified calculation method, which does not require the use of a base period from the 1980s. Instead, the base period consists of the three tax years immediately preceding the year for which the credit is being calculated. That credit is available at a reduced rate, but that rate was recently raised from 12 to 14 percent.
Also, the IRS has labeled this credit as a tier one audit issue. If the credit is taken on a return that gets audited, IRS policy is for the agent to refer the issue to the IRS technical specialists for a more in-depth review. Since all amended returns are reviewed by IRS personnel, any amended return that is filed to take the credit that was missed or just not taken on the original return will be referred to the technical specialists under IRS policy.
The requirements for contemporaneously documenting the data used in the calculation of the credit can also be intimidating, and many tax professionals have been leery about taking it for that reason, as well. The IRS has imposed stringent standards for documentation of the amounts of expenses included in the calculation. However, the courts have held against the IRS in some recent cases, and more reasonable standards can be applied under the law as it currently stands.
Finally, the credit for increasing research is a general business credit and, until recently, general business credits have not been available to offset the alternative minimum tax (AMT). This has particularly impacted flow-through entities, which may have some owners who are subject to the AMT and some who are not. A business may not even be aware of the AMT status of all of its owners, and therefore has had a hard time evaluating the true tax savings of the credit. However, the Small Business Jobs Act changed that. Going forward, for new credits arising in 2010, general business tax credits will now be able to offset the AMT. That’s huge for businesses — smaller businesses, in particular.
What would you say to a business owner who says pursuing the credit seems too complex?
It is time-consuming, but the biggest thing is documentation of what was done. Much of the time involved is in pulling data together, but many companies already do that. If there is a project the company is working on, it tracks the costs going into that project and the time spent working on it. Often companies are not aware that they have already compiled the documentation they need to take advantage of the credit.
Can businesses sort out the intricacies of this tax on their own?
With the complexity of the calculations and the nuances of the credit, it is more than most businesses can handle on their own. An experienced adviser can help sort it all out by being aware of the technical points of the credit and knowing where to draw the line in taking a position. An adviser who is knowledgeable about the mechanics and the components of the credit, and who knows the current state of the law, can advise a client when to take a credit without taking on undue risk.
By talking to an adviser, you can determine whether the credit makes sense for your business and, if it does, what steps you should be taking to document your expenditures.
John Carey, CPA, JD, is an associate director for the tax department at SS&G. Reach him at (330) 668-9696 or JCarey@SSandG.com.