IC-DISCs: Tax Savings for US Exporters
A unique tax incentive vehicle exists for taxpayers who manufacture or produce goods within the United States and then export those goods to foreign jurisdictions. The IC-DISC entity – formally known as the Interest Charge Domestic International Sales Corporation – allows for income to be taxed at qualified dividend rates via a simple transactional structure between the exporter and the IC-DISC. This benefit can be significant when considering the maximum marginal tax rates for ordinary income and qualified dividend income are 39.6% and 23.8%, respectively. While ultimately realizing the tax savings requires the exporter to establish a separate corporate entity, the cost of initiating and maintaining the IC-DISC is relatively low.
Formation and Structure
The IC-DISC structure begins with formation of a C-Corporation by the shareholders of the exporter. An election is subsequently filed (with the consent of all shareholders) to treat the new entity as an IC-DISC for federal tax purposes. This election must be made within 90 days prior to the beginning of the year in which it first desires to be treated as an IC-DISC. Although the corporation can be formed in any state, consideration should be given to state income and excise taxes when choosing a particular state.
There are several requirements, however, the entity must meet to qualify and retain its IC-DISC status:
- 95% of gross receipts must be “qualified export sales”
- 95% of assets at year-end must be “qualified export assets”
- The corporation must maintain a separate bank account
- The corporation may have only one class of stock
- The corporation must have capital of at least $2,500
- No more than 50% of the value of the exported property may consist of imported components
The IC-DISC Commission and Dividend
The commission agreement executed between the exporter and the IC-DISC is the primary mechanism by which the exporter realizes tax savings. This agreement generally provides for a commission to be paid to the IC-DISC that is fully deductible by the exporter. The commission is limited to the greater of 4% of the exporter’s qualified export receipts or 50% of the exporter’s income derived from qualifying export profits. Although the IC-DISC is technically organized as a C-Corporation, the commission income is exempt from income tax under Internal Revenue Code Section 991, effectively eliminating the double taxation regime for C-Corporations. The commission income received by the IC-DISC is distributed to its shareholders as qualified dividends. Thus, through the IC-DISC structure, shareholders who are individuals are now taxed at a maximum rate of 23.8% on these dividends instead of a maximum ordinary rate of 39.6%.
Alternatively, the IC-DISC has the opportunity to delay distributing the dividend to its shareholders and defer tax on the commission income related to the first $10 million of qualified export receipts. Shareholders of the IC-DISC will then avoid taxation on this income but be assessed an interest charge on the tax that would have been paid had the distribution been made. Income from amounts in excess of $10 million cannot be deferred because it is deemed distributed and taxed to the shareholders, whether an actual distribution is made or not.
The IC-DISC is becoming an increasingly popular vehicle for manufacturing taxpayers with sales extending to foreign arenas. Contact one of our professionals for consultation on the IC-DISC tax savings opportunities for your company.