Diving In
Small and medium-sized companies are always looking for strategies to save money and minimize their tax liability—even when they’re not being challenged with keeping their businesses profitable throughout a global pandemic.
A relatively unknown but powerful tool to reduce taxable income is an Interest Charge Domestic International Sales Corporation, or “IC-DISC.” IC-DISCs are not temporary tax shelters. By contrast, they offer permanent tax savings to U.S. based exporting businesses and manufacturers. By transferring income to a tax-exempt IC-DISC through an export sales commission, a company can increase global competitiveness by reducing their overall tax liabilities.
The Functionality of IC-DISCs
For companies that sell or lease qualified property or provide specific services overseas, IC-DISCs allow for the creation of a separate but related entity (the IC-DISC) to act as its foreign sales agent. Because of its tax-exempt status, the IC-DISC receives commissions from the U.S. business on qualifying export sales. These commissions are deductible expenses to the existing business. The IC-DISC, however, as its own business entity pays no tax on the commissions it receives. Instead, the IC-DISC distributes qualified dividends to its shareholders which are generally taxed at a preferential rate ranging between 15 and 20% (plus a 3.8% Net Investment Income Tax) resulting in a tax rate arbitrage of up to 13.2 percentage points below the top individual income tax rate of 37%.
Eligibility
An IC-DISC must comply with certain requirements in order to achieve the desired results, including:
- Incorporation in one of the 50 states or in the District of Columbia,
- Filing of an election with the Internal Revenue Service to be treated as an IC-DISC for federal tax purposes,
- Maintenance of separate bank accounts and books and records from the existing business entity,
- Maintenance of a minimum capitalization of $2,500 for each day in which the corporation is to be treated as an IC-DISC,
- Have a single class of stock, and
- Meet an annual test requiring that at least 95% of the IC-DISC’s gross receipts and assets be related to the export of property, and that the value of the property sold is at least 50% attributable to U.S.-produced content.
What Kinds of Businesses Could Benefit from the Use of an IC-DISC?
Manufacturers and distributors of domestically grown, produced, or manufactured “qualified export assets” may take advantage of the IC-DISC tax regime. This benefit is available to manufacturers of U.S. product, as well as distributors of U.S.-manufactured products and components, lessors of U.S. property used abroad, software developers, and service providers such as architects, engineers and contractors engaged for certain overseas projects.
How are the Tax Benefits of IC-DISC Determined?
The IC-DISC’s tax benefits are especially attractive to owners of “pass-through” businesses such as partnerships, S-corporations, and limited liability companies (“LLC”), because these entities may not benefit from the Foreign Derived Intangible Income (“FDII”) deduction, which provides benefits to corporate exporters. The tax benefits on export sales are available as soon as the IC-DISC is incorporated and the election to be treated as an IC-DISC is filed.
The existing business pays a tax-deductible commission to the IC-DISC equal to the greater of either 4% of the existing business’s gross receipts from qualified exports (subject to a no-loss limitation), or 50% of its net income from qualified exports. The commission expense paid by the existing business reduces its taxable income as an ordinary business deduction.
Maximizing Your IC-DISC
Eligible IC-DISC companies should also consider and take advantage of other products specifically created for exporters and manufacturers. In combination with the Small Business Administration’s (SBA) Export Working Capital Lines of Credit, for example, you can also ensure a proactive working capital strategy supporting your business goals. Together, IC-DISCs and other exporting products offer small and medium-sized U.S. companies innovative financial strategies to stay ahead of the game and challenge their larger competitors.
Thank you to our partners at BDO United States for providing this article to First American Bank.
Questions? Reach out to your tax advisor or contact the authors Tony Argiz at targiz@bdo.com and John Vides at jvides@bdo.com.
