I generally try to keep this blog focused on simple topics, but living in a port city like Savannah, this topic has a wider appeal to our clients and community. There is an old and in most cases forgotten export tax strategy known as the Interest Charge-Domestic International Sales Corporation (IC-DISC), which dates back to the ’70s. There is renewed interest in these structures since Congress extended their viability until at least the end of 2012.
For U.S. exporters operating their business via a sole proprietorship or pass-through entity (e.g., limited liability company (LLC), S corporation, or limited partnership (LP)), the IC-DISC benefit is essentially tied to the differential between the qualified dividend rates and the ordinary income tax rates.
In addition to benefiting sole proprietorship’s and pass-through entities, exporters operating their business via a C corporation can benefit by using the IC-DISC to eliminate double taxation on a majority of their export income, as well as to reduce the need to incur additional payroll taxes on income paid to their shareholders/officers.
Exporters can now recoup, or even exceed, their tax savings on their product revenue—and in some cases service revenue as well—by creating an IC-DISC. This benefit is also available to companies whose products are exported by another party or “ultimately used” outside the U.S. by customers.
The IC-DISC is a “paper” entity used as a tax-savings vehicle. It does not require corporate substance or form, office space, employees, or tangible assets. It simply serves as a conduit for export tax savings. An important feature of the IC-DISC is that shareholders can be corporations, individuals, or a combination of these.
In its simplest for here is how an IC-DISC works:
- Owner-managed exporting company forms a special U.S. corporation that elects to be an IC-DISC. The election is made on Form 4876-A. The form must be filed within 90 days after the beginning of the tax year. For any tax year that is not the corporation’s first tax year, the election must be made during the 90-day period immediately preceding the first day of that tax year
- Exporting company pays the IC-DISC a commission.
- Exporting company deducts the commission from ordinary income taxed at up to 35%
- IC-DISC pays no tax on the commission as long as certain qualification standards are met, such as the 95% qualified export assets and the 95% qualified export receipts requirements of Code Sec. 992(a)(1) ). Qualified export receipts in excess of $10 million per year are not eligible for deferral of tax, although deferral should not be a primary objective during this low-tax dividend environment.
- Shareholders of an IC-DISC are not taxed until the earnings are distributed as dividends. However, the shareholders must pay annual interest on the tax deferred. The interest charge is computed on Form 8404. Shareholders that are individuals pay income tax on qualified dividends at the capital gains rate of 15%. C Corporation shareholders are automatically considered to have received 1/17th of the IC-DISC’s taxable income, even if no distributions are made.
- The result may be a 20% or more tax savings on the commission.
If you have any questions regarding these structures, please do not hesitate to contact us.