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.
Doug Eckert, Member, International Tax Practice Leader, Brown Smith Wallace LLC
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 protected]