New Tax Law Extends Benefit of the

IC-DISC for Exporters 

Neil Keller, CPA, Shareholder - Tax   email
January 2011

The recent tax legislation offers a tax savings opportunity for companies that ship some of their products to foreign countries. The tax code establishes a vehicle, called an Interest Charge - Domestic International Sales Corporation (IC-DISC), that generates tax savings for companies with exports. Companies that export property as well as firms that perform certain engineering and architectural services on foreign construction projects may benefit from establishing an IC-DISC.

The main benefit of employing an IC-DISC comes from the reduced tax rate on "qualified dividends." This is due to the fact that dividends received from an IC-DISC are taxed at a federal rate of 15 percent while the corresponding commission expense is deductible at a 35 percent tax rate. This difference in rates translates into a 20 percent tax savings on the income from this export activity. If the tax rate on dividends had not been extended for two years to remain at the 15 percent rate it would have jumped to the top ordinary rate of 35 percent or more, and thus essentially eliminated the tax benefit of the IC-DISC. The tax rate extension thus provides two more years of tax savings for the IC-DISC from the qualified dividends, and companies that export should evaluate if the IC-DISC will be beneficial to them. For an example of two different calculations click here.

The IC-DISC is a separate corporation that does not pay any tax. In addition, the IC-DISC generally does not have any employees or perform any specific activities. It is essentially a "paper company" that is created by tax code to encourage companies to export their products.

Property qualifying for sale through an IC-DISC must be manufactured, produced, grown or extracted in the United States, and at least 50 percent of its value must be attributable to United Sates content. Further, the property must be delivered and used outside the United States. Indirect exporting may qualify as well. For example, if a company sells its manufactured goods to another domestic company which exports the product without further manufacturing, those goods could qualify for sale through an IC-DISC. The company would need to be able to document that the end-product was exported to a foreign country.

An IC-DISC operates as follows:

• The exporting company sets up the IC-DISC. The shareholders of the exporting company and the IC-DISC are generally the same and ownership typically remains in the same percentages. Alternatively, the IC-DISC could be owned by the exporting company.

• The exporting company pays a commission to the IC-DISC based on their foreign sales. Tax rules provide that the commission can be up to the greater of: Four percent of the revenue generated from the qualified export sales, or 50 percent of the taxable income from the qualified export sales.

• The exporting company can claim a tax deduction from its income for the commission it pays to the IC-DISC. The deduction provides a tax benefit depending upon the company's tax bracket (up to 35 percent at current tax rates).

• An IC-DISC is a tax-exempt entity; it pays no federal income tax on the income it receives from its commission revenue.

• The IC-DISC pays its income to its shareholders in the form of dividends.

The IC-DISC shareholders treat these distributions as qualified dividends and pay federal income tax at a 15 percent rate. This lower tax rate is the key distinction that makes the IC-DISC an attractive vehicle to consider.

There are many technical requirements for the IC-DISC that must be met in order to take advantage of these tax savings, including the following provision:

• The IC-DISC and its shareholders must make an election to be treated as an IC-DISC within 90 days of the beginning of the tax year.

• The IC-DISC must satisfy certain tests for both qualified export assets and qualified gross receipts.

• Any taxable income related to qualified export gross receipts in excess of $10,000,000 is subject to tax. The IC-DISC is ideal for companies with foreign sales that range from $1,000,000 to $10,000,000. Keep in mind the exporting company may also sell its products within the United States. Any percentage of foreign sales is permitted; what is important is the amount of foreign sales.

• If the IC-DISC income is not distributed timely to its shareholders, then the shareholders are assessed an interest charge on the tax they would pay if the income had been distributed.

• The IC-DISC must be a U.S. corporation with only one class of stock and with at least $2,500 in par value stock.

• It should also be noted that Wisconsin does not recognize IC-DISCs but does provide special rules on how to treat IC-DISCs for Wisconsin tax purposes.

It is important to form the IC-DISC and file the election early in the tax year, because the benefits are only available on a prospective basis. For example, an IC-DISC established on March 1, 2010 will only be able to receive a commission on foreign sales made on or after March 1, 2010, not for the entire 2010 year.

For more information or to discuss setting up an IC-DISC, please contact Neil Keller (262/754-9400).