If your company exports the United States manufactured products or provides services to customers located outside of the United States, then you may consider forming an Interest Charge Domestic International Sales Corporation (“IC-DISC”) to reduce federal taxes. Exporters can realize federal tax savings of up to 15 percent by using an IC-DISC for such foreign sales.
An IC-DISC is a United States corporation that has elected, for federal income tax purposes, to be treated as an IC-DISC. An IC-DISC operates as a principal or as an agent engaged primarily in the selling and leasing of export property on behalf of another United States manufacturer. Typically, the IC-DISC and that other manufacturer are owned by the same shareholders or by the manufacturer it serves. If federal law requirements are met, then the IC-DISC will not be subject to federal income tax. Instead, the IC-DISC effectively converts a portion of its net export income, which is taxable at ordinary income rates as high as 39.6 percent, into qualified dividends generally taxed at 20 percent when paid to its shareholders.
The IC-DISC must be a separate entity from the related manufacturer or supplier. It must maintain its own bank account, keep separate accounting records, and file annual tax returns. But, the IC-DISC is not required to perform any invoicing or services and nor is it required to have an office, employees, or even tangible assets. Specifically, an IC-DISC must be incorporated in a U.S. state or in the District of Columbia, have a single class of stock with a par or stated value > $2,500, have the same tax year as the primary shareholder, and meet an annual qualified export receipts test and a qualified export assets test. In order to satisfy the last requirement, at least 95 percent of an IC-DISC’s gross receipts and assets must be related to the export of property whose value is at least 50 percent attributable to US-produced content.
An IC-DISC can generate tax savings through a series of transactions. On each sale of qualifying property or services to foreign customers, the related manufacturing company pays a deductible sales commission to the IC-DISC (which is equal to the greater of a) 4 percent of the manufacturer’s gross receipts from qualified exports, or b) 50 percent of the manufacturer’s net income from qualified exports, which produces a tax benefit of up to 39.6 percent. Since the IC-DISC is a tax-exempt entity, it recognizes no income on the receipt of the sales commissions from the manufacturer. Before the end of its taxable year, the IC-DISC distributes its sales commission receipts to its shareholders as dividends. The shareholders of the IC-DISC are taxed on the dividends at their respective qualified dividend federal rates, at a maximum for individuals of 23.8 percent, the resulting net tax benefit for federal alone is a tax rate cut of up to 15.8 percent for individuals.
Family-held businesses, such as pass-through entities like partnerships, S corporations, or limited liability companies and even C corporations can enjoy IC-DICS benefits. For pass-through entities, dividends the IC-DISC distributes will qualify for the 2013 23.8 percent rate for individuals. For C corporations, however, the C corporations’ individual shareholders should form the IC-DISC. If the IC-DISC is set up as a subsidiary by the corporation and it instead owns the IC-DISC stock, then the dividends when paid to the corporation by the subsidiary are taxed as ordinary income resulting in no tax savings.
An IC-DISC’s tax benefits are not retroactive, and these tax savings are available only for export sales made after the IC-DISC is established. Thus, the sooner you act, the greater your tax savings. IC-DISCs continue to provide an opportunity to shift income to lower income tax brackets by taking advantage of the difference between ordinary income tax rates and qualified dividend rates, as well as to defer taxes on export sales.
If your company has questions about incorporating an IC-DISC structure into its operations, please contact your attorney and CPA or Christopher Hunt or David Lewis of Krugliak Wilkins who are well versed in this area and who have contributed significantly to this article.
NOTE: The foregoing discussion is intended to provide general guidelines on IC-DISC’s and the potential tax benefits associated therewith. It is not intended to address specific situations that may arise with respect to the use of an IC-DISC and any tax consequences in connection with its use. Therefore, this communication is not and should not be considered a substitute for direct legal advice that may be necessary for any specific situation or issue with an IC-DISC.
To ensure compliance with requirements imposed by the Internal Revenue Service, any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter addressed herein.
James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway
New Philadelphia, Ohio 44663