By Kevin Begley
While the Interest Charge - Domestic International Sales Corporation (“IC-DISC”) has been around since 1971, too few small- to medium-sized manufacturers have taken advantage of the potential permanent tax savings that this incentive vehicle offers. The IC-DISC is the only remaining export incentive available. It’s regime has never been challenged by the European Union or the World Trade Association, as it’s predecessors had been. It is specifically provided for in the Internal Revenue Code and is not difficult to create or complex to administer. It does not require office space, employees or tangible assets. In fact, you, the taxpayer, actually determine just how complex you want to make the process if you believe the benefits of complexity are worth the additional cost to compute greater permanent tax savings. Benefits are available whether the taxpayer/ manufacturer is either a pass-through entity or a “C-Corp”. IC-DISC benefits also can be used in conjunction with the benefits offered by the IRC section 199 Domestic Production Activities deduction.
What is the IC-DISC Benefit
The IC-DISC utilizes the tax rate arbitrage between ordinary income and dividend tax rates to enable a permanent tax rate savings of 20% for pass-through entities and 29.75% for privately owned C corporations. Creation of a brother-sister IC-DISC (which must be a U.S. corporation, generally with identical ownership as the manufacturing/service provider entity) and having the manufacturer/service provider “pay” a commission to the IC-DISC on up to $10 million of “export” sales generates a tax deduction for the manufacturer/ service provider for such commissions. However, the IC-DISC is a tax-exempt entity for U.S. tax purposes and therefore does not recognize the commission as taxable income. Instead its shareholders recognize income upon distribution from the IC-DISC and such income is treated as qualified dividends, which for individual shareholders are currently taxed at a 15% rate. Qualified export receipts not only include sales of manufactured goods, but also include rent for the use of export property outside the U.S., engineering or architectural services for construction projects outside the U.S. and services related to export sales such as warranty, installation, repair and maintenance services. The DISC commission itself equals the greater of 50% of the combined taxable income (“CTI”) of the related manufacturer/service provider and the DISC or 4% of qualified export receipts (limited to 100% of CTI) plus 10% of export promotion expenses.
The example in Appendix A illustrates how this benefit works. If the taxpayer has individual products or product lines, further analysis would only add to the benefits afforded to the shareholders of the IC-DISC. The taxpayer is afforded substantial flexibility in optimizing the tax benefit since the commission calculation is not considered an accounting method.
The IC-DISC offers other avenues for planning as well. It can serve as a vehicle for incentive or deferred compensation by allowing a valued employee to be a shareholder. In addition, it can be used as a means of wealth transfer by having either a traditional or Roth IRA as a shareholder.
We have also attached Appendix B which lists technical requirements, as well as definitions of key terms.
The above is meant to highlight the potential benefit of adding an IC-DISC to the structure of small- to mid-sized companies which engage in exporting activities and is not meant to be an exhaustive discussion of the IC-DISC.
Click here to download a PDF of this article that includes Appendix A and B.
We Can Help
The professionals at Decosimo stand ready to assist companies in determining the best way to maximize the benefits associated with this unique tax incentive. Please contact Kevin Begley at 513.562.1237 or Jason Hamilton at 865.521.1672.