First introduced by Congress in 1971 to help U.S. businesses battle a growing U.S. trade deficit, an Interest Charged Domestic International Sales Corporation (“IC-DISC”) can help business owners realize permanent tax savings and other benefits for their export business operations. An IC-DISC achieves these tax rate savings by converting ordinary business income, which is often taxed at the top rate of 39.6%, to dividend income, which is taxed at between 15% and 23.8%, depending on total income. Thus, a U.S. company engaging in qualified exports can realize a permanent tax rate savings of up to 24.8% through the use of an IC-DISC.
Here is how an IC-DISC works:
First, an exporter creates a new corporation and seeks approval from the IRS to have this entity treated as an IC-DISC.
In order to receive this approval and maintain its status, an IC-DISC must be a domestic C-Corporation. While C-corporations are not usually used as business entities, the attraction of the C-Corporation in this situation is that the income into it is not taxable; and, it can distribute dividends to shareholders that are taxed at a lower rate than a flow-through entity would allow.
The IC-DISC must uphold certain corporate formalities and is required to keep its own bank account, maintain separate accounting records, and have a single class of stock valued at $2,500.00 or greater.
It does not, however, require employees, office space or tangible assets.
One additional requirement is that at least 95 percent of the IC-DISC’s gross receipts and assets must be related to export property comprised primarily of domestic goods.
If more than 50% of the fair market value of the exported goods is attributable to foreign materials, the entity cannot take advantage of IC-DISC benefits.
Once approved by the IRS, the exporter and IC-DISC enter into a commission agreement.
Under the agreement, the exporter pays a certain amount of commissions to the IC-DISC. The exporter can elect to pay commissions up to the greater of 50% of its export net income or 4% of its export gross receipts. The exporter can now deduct these commissions from its ordinary income, which would have otherwise been taxed at a rate up to 39.6%. The IC-DISC itself is not taxed on the income from these commissions. Instead, the IC-DISC passes the commission income to its shareholders in the form of dividends, which are subject to a much lower tax rate. Similarly, if the exporter is a flow-through entity such as an S-Corporation or LLC, the IC-DISC serves to convert a portion of the exporter’s highly taxed ordinary income into the lesser taxed qualified dividend income.
In addition to these permanent tax savings, an IC-DISC can provide other benefits. An exporter can choose to defer the taxation of up to $10MM of qualified export receipts per year before their ultimate distribution to the IC-DISC’s shareholders. If an exporter chooses to defer, the shareholders pay a nominal interest charge to the IRS. The IC-DISC may also be used as an estate planning tool. Because the IC-DISC shareholders do not have to be the same as the exporter’s shareholders, an exporter may choose to give some IC-DISC shares to children or other family members who are taxed at a lower dividend rate. Finally, an exporter may choose to use the IC-DISC as part of its employment compensation packages by awarding IC-DISC shares to management personnel or top earners.
In summary, there are significant tax and estate planning opportunities for companies who design or manufacture in the U.S. and export those products and services. The IC-DISC has been in existence for many years and is a widely accepted method of saving taxes.
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