US businesses earning profits from the export sale of US manufactured products, or from certain qualifying services, can benefit from an Interest-Charge Domestic International Sales Corporation (IC-DISC). Despite is rather intimidating name, an IC-DISC can provide small and medium business owners with significant federal tax savings on their net export sales. Specifically, IC-DISCs provide an opportunity for a company to reduce the tax on 50% of its export income by more than 50%. Since IC-DISC profits are taxed at the qualified dividend rate (currently at 20%) as opposed to ordinary income tax (top rate currently 39.6%, before the Medicare surcharge of 3.8% on net investment income). In today's global marketplace, IC-DISCs serve an important role in promoting domestic job creation and retention, and in assisting US companies competing for global business opportunities.
What is an IC-DISC?
An IC-DISC is a corporation organized by a US exporter that elects treatment as an IC-DISC. The new company serves as a commission sales company for the exporting company, and under the IC-DISC rules, is presumed to have participated in the export sales activity, entitling it to a commission.
The exporting company's commission payments are deductible expenses. Generally, three types of companies can take advantage of the IC-DISC provisions:
• A company that directly exports goods it manufactures.
• A company provides architectural or engineering services that are conducted in the US for a construction project taking place outside of the US.
• A company that manufactures a good that is a component of a product that is exported.
How does an IC-DISC achieve its tax benefit?
Under safe harbor pricing rules, the IC-DISC's commission determined under the agreement with its related exporter can be established as the greater of i) 50% of the next export sales income, or ii) 4% of the gross export sales revenue, limited to the combined taxable income before the commission expense.
The IC-DISC pays no federal income tax on commission that it distributes to its shareholders. Those shareholders are taxed on the IC-DISC distribution of the net commission revenues (actual or deemed) at the "qualified" dividend rate of 20%. Typically, dividends should be paid on an annual basis. The exporting company receives the benefit from the reduction of its taxable income by the amount of the commission, while the IC-DISC shareholder is taxed on receipt of a qualified dividend, as opposed to receiving its allocable share of taxable ordinary income from an S corporation/flow through entity, or the distribution from a regular corporation that has already paid a corporate level tax.
Tax deferral is available on commission income derived from gross export sales revenues up to $10,000,000 where the commission income is not distributed to its shareholders. This deferred income will be taxed as a dividend when distributed to the exporter. Interest will be imputed on the deferred amount and taxed currently to the shareholders (i.e., the "interest-charge"). To be clear, however, the tax benefit from the rate differences discussed above applies on total export sales as long as the "excess" commission income is distributed.
Who benefits from an IC-DISC?
For exporting companies doing business as a closely-held corporation, IC-DISCs are typically established by the exporter's shareholders. The available tax benefit is the different between the exporting company's corporate tax rate and the qualified dividend rate of the individual shareholders (35%-20% plus 3.8% healthcare tax = 15%).
S Corporations, partnership, or limited liability companies treated as a partnership for tax purposes, can establish the IC-DISC as a separate corporation owned by the exporter's shareholders, or as a wholly-owned subsidiary of the exporter. IC-DISC dividends to the IC-DISC shareholders as direct dividends (or indirectly, as a pass-through distribution from a partnership or limited liability company) will be taxed as qualified dividends and taxed at a reduced rate. The tax benefit is the different between the marginal individual tax rate for the individual shareholder/member and the qualified dividend rate for the individual shareholders (39.6% plush .9% healthcare tax, and the 20% qualified dividend rate plus 3.8% healthcare tax = 16.7%).
Does your company qualify to use this unique strategy? Give us a call at 281-488-2022.