IC-DISC: The Only Export Tax Incentive for Manufacturers and Distributors
The Interest Charge-Domestic International Sales Corporation (IC-DISC) is the only remaining export tax incentive available to U.S. manufacturers and distributors of U.S. made products and services. Privately held U.S. companies with $1.5 million of qualified export sales and/or $150,000 of export profit should consider the tax saving benefits of establishing an IC-DISC.
What is an IC-DISC and how does it work?
An IC-DISC is a C Corporation that timely elects to be an IC-DISC, which is a non-taxable entity for federal tax purposes. The most common arrangement is a Commission DISC in which the IC-DISC acts as a commission agent for the related supplier. The commission is paid by the related supplier to the IC-DISC. Qualified DISC income is exempt from federal income tax and is often excluded from state income tax, as well.
The commission paid by the related supplier is an ordinary deduction, which generally results in a 39.6% (ignoring state taxes) tax savings when a flow-through entity structure is in place. The IC-DISC pays a qualified dividend to its shareholders that is taxed at 23.8% (20% qualified dividends rate plus 3.8% net investment income tax). The net result is a 15.8% tax savings. When the related supplier is a C Corporation, tax savings can be as high as 28% because of the potential double taxation! Click here to see an example of the tax savings comparison.
What are the requirements?
- It must be a domestic (U.S.) corporation with only one class of stock.
- Capitalization of stock must be at least $2,500 and the contribution should be paid in cash within 90 days of incorporation.
- The IC-DISC election must be filed with the IRS within 90 days of incorporation.
- The IC-DISC must meet the 95% qualified export receipts test and 95% qualified export assets test.
- The DISC must maintain separate books, records and suppliers agreement(s).
- Payment of the estimated commission must be made within 60 days after year-end.
How are qualified export sales identified?
Export property generally must meet three tests.
- It must be manufactured, produced, grown or extracted in the U.S. by a person other than a DISC.
- It must be held primarily for sale, lease, or rental, in the ordinary course of trade or business for direct use, consumption, or disposition outside the U.S.
- The foreign content (articles imported into the U.S.) of the product cannot exceed 50% of the final sales price.
Engineering and architectural services for construction projects outside the U.S. may also qualify.
How is IC-DISC income calculated?
The commission is calculated using the inter-company pricing rules set forth by the Internal Revenue Code and Treasury Regulations. The pricing rules are subject to complex limitations and grouping rules. Careful analysis and structuring of export activity is important to optimize tax savings.
Administrative pricing rules are only applicable to transactions between an IC-DISC and its related supplier (commission calculation). This is the most common arrangement. There are three pricing methods available: 4% of export gross receipts, 50% of combined taxable income (CTI) and §482 arm's length pricing.
Combined Taxable Income (CTI) is the limiting factor in determining DISC taxable income. It is the combined taxable income of the IC-DISC and its related supplier with respect to each qualified export transaction. In order to maximize the IC-DISC tax exempt income, CTI needs to be maximized. Click here to see an example of the pricing methods.
A subset of the 50% combined taxable income method is marginal costing rules, which uses an overall profit percentage (OPP) to "average up" the amount of profit. This is normally used where domestic sales are more profitable than export sales.
What are the tax filing requirements of the IC-DISC and its' shareholders?
The IC-DISC must file Form 1120-IC-DISC and supporting schedules on an annual basis. The return is due 8-1/2 months after the year-end of the IC-DISC. No extensions are available. State tax filing requirements vary from state to state.
Distributions from the IC-DISC are reported on supporting schedule K, Shareholder's Statement of IC-DISC Distributions. The dividend is included on the shareholder's tax return. There is not a requirement to pay a dividend annually, but then a deferral strategy must carefully follow specific rules.
In addition, Form 8404 Interest Charge on DISC-Related Deferred Tax Liability is required when there is a deferral on distributions. Because of the rules, there is effectively a 1 year deferral on distributions without an interest charge. The interest rate is very low because it is based on the base period T-bill rate. For 2015, the rate was only .24%. Therefore, this becomes a low cost loan from the government for the deferral benefit. The form is filed by the taxpayer shareholder of the IC-DISC, not the IC-DISC.
Victor (Sandy), CPA
For more than 35 years, Victor (Sandy) Jose has assisted clients with their inbound and outbound investments, Foreign Account Tax Compliance Act (FATCA) compliance, Offshore Voluntary Disclosure Program projects, as well as other withholding and reporting projects. Sandy has extensive and broad based global experience in the automotive and manufacturing industries. Contact Sandy at email@example.com or (248) 244-3082.