IRS: Only 25% of Potential IC-DISC Tax Benefits Being Captured

Closely-held companies that export have a tax-savings opportunity by creating an Interest Charge – Domestic International Sales Corporation (IC-DISC). While about 6,000 small and medium businesses take advantage of the tax incentives of an IC-DISC, the IRS statistics suggest that only about 25 percent of the potential IC-DISC benefits that are available are actually being captured.

Understanding IC-DISCs

The IC-DISC is a creature of the Internal Revenue Code that provides a significant tax incentive for business owners who manufacture and export. Small to mid-size businesses can set up a separate corporation that elects to be treated as an IC-DISC. Businesses can allocate approximately half of the profits from export sales to this entity. The IC-DISC is not subject to tax. Upon distribution of profits from the IC-DISC to its shareholder(s), the distribution is taxed as a qualified dividend. A company with $1 million of export sales that generates $100,000 of export profits could expect to save $8,000-$13,000 of income taxes annually if they have an IC-DISC in place.

Exports Reach New Heights

Nearly 30,000 businesses have started exporting for the first time since the National Export Initiative began in 2010. The Obama administration created the initiative as a strategy to double U.S. exports between 2010 and the end of 2014. In 2013, Missouri exports totaled $12.91 billion, almost a 79 percent growth since 2003. That’s on trend with the rest of the country, which has had four straight record-breaking years of exports, with an all-time height of $2.3 trillion in 2013.

The IC-DISC strategy should be evaluated for companies with qualified export receipts of $1 million or greater or companies with annual taxable income from qualified export receipts of $100,000 or greater. The definition of qualified export property is broader than most think: Export property must be manufactured in the U.S. and must have a minimum of 50 percent U.S. content to qualify. What counts as manufactured goods is also more comprehensive than some people might realize. It can include:

• Engineering and architectural services that are handled in the U.S. for a project outside the country

• A component good that is included in a product that is exported may qualify

• Films shot in the U.S. that are distributed abroad

• Software and agricultural products exported

Benefits for Partnerships and Corporations

An IC-DISC will provide a different tax benefit to an S-Corporation or Partnership versus a C-Corporation. When used in conjunction with a Partnership or an S-Corp, the IC-DISC on a fully distributed basis has the effect of converting ordinary income into qualified dividend income and saves approximately 8 cents for each dollar of export profits in income taxes. Normally, a C-Corp would pay approximately 35 percent on its profits and an additional 20 percent when those profits are distributed as dividends. By using an IC-DISC, the corporate level tax is avoided while distributions from the IC-DISC are qualified dividends. The math works out such that when used in conjunction with a C-Corp, the IC-DISC saves approximately 13 cents for each dollar of export profits in income taxes on a fully distributed basis.

Set Up and Compliance

Setting up an IC-DISC generally involves the cost of hiring an attorney to incorporate the entity and provide the contract between the IC-DISC and the related manufacturing company. It also involves hiring a tax consultant to quantify the qualified export sales and to determine the proper ownership structure for your IC-DISC. But since some companies are saving millions for this relatively low investment, it’s worth exploring the potential. The IC-DISC is allowed by statute in the Internal Revenue Code. Therefore, no tax risk is associated with this idea. Rather, the IC-DISC must properly comply with the requirements set out in the tax laws. The penalty for failing to comply is losing the IC-DISC benefit.

Original Post By:  Doug Eckert

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Doug is a Partner and the International Tax practice leader in the Tax Services group of Brown Smith Wallace. With over 24 years of experience, he is skilled at advising on international expansion, developing global tax strategies, assessing global tax risk management and navigating the changing global tax environment.

His areas of expertise include global tax strategy development, cash repatriation strategies, transfer pricing, cross border disputes management, exporting initiatives, federal tax audit management, international tax compliance, and international expansion.

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