The IC-DISC – Don’t Let the Tax Benefit for Exporters Slip By

Neil Keller, CPA, Shareholder - Tax   email
January 2010

Companies that ship products to foreign countries may be able to take advantage of a tax-saving opportunity found in the Internal Revenue Code. Selling to foreign countries using an Interest Charge – Domestic International Sales Corporation (IC-DISC) may allow companies to realize federal income tax savings. 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 IC-DISC is a separate corporation that does not pay any tax. In addition, the IC-DISC does not have any employees or perform any specific activities. It is essentially a "paper company" that is created by the 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 company that 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 have the same ownership percentage.
• The exporting company pays a commission to the IC-DISC based on its foreign sales. Tax rules provide that the commission can be up to the greater of 4 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 out its income to its shareholders in the form of dividends.
• The IC-DISC shareholders treat these distributions as qualified dividends and thus, pay federal income tax at a 15 percent rate.
• The overall tax result is that the shareholders of both entities enjoy 20 percent tax savings on the commission income created by the IC-DISC (a 35 percent regular tax rate benefit for the tax deduction of the commission, less a 15 percent tax rate on dividends received from the IC-DISC).

The diagram below further illustrates the operation of an IC-DISC.

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 provisions.

• 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.
• 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).