By: Robert E. Grote, CPA, Partner, Manufacturing & Distribution Practice Leader
IC-DISC? This is an acronym for Interest Charge – Domestic International Sales Corporation. The IC-DISC is one of the few remaining export incentives still available to U.S. companies. Others, including the Extraterritorial Income Exclusion, have been repealed due to sanctions imposed by the World Trade Organization. The IC-DISC has been around since 1984, but has never been a target of the World Trade Organization. Due to the extension of the Bush tax cuts, 2011 rates will carry over to 2012. Although it remains to be seen whether or not those rates will carry past 2012, the capital gains tax rate is usually lower than the rate for income, so IC-DISC will likely still save you money if rates change in 2012.
IC-DISC is especially effective these days due to the currently low dividend rate of 15%. The use of an IC-DISC allows a non-public company to convert a portion of its federal taxable income that would normally be taxed at a 35% rate to a tax rate of only 15%. This is a permanent 20% savings. The concept is simple, but the IC-DISC structure is more complicated than some previously available incentives. The export company must be a sole proprietor, S corporation, Partnership or LLC and the IC-DISC must:
- Be a separate entity
- Have one class of stock with a minimum par value of $2,500
- Elect to be treated as an IC-DISC
- File a separate federal tax return
- Pass 95% Qualified Gross Receipt Test
- Pass 95% Qualified Export Asset Test
- Maintain separate cash accounts and books and records
Additionally, a cash payment must actually be made to the IC-DISC, limiting the resources available to the exporter for working capital requirements.
There are several steps involved in the function of an IC-DISC structure:
- The exporter pays commissions to the IC-DISC. The commission can be calculated at a rate of 4% of the gross receipts on export sales or 50% of the taxable income relating to export sales, whichever is higher.
- The commissions paid are deductable by the exporter and reduce income normally taxed at a 35% rate.
- Because the IC-DISC is not subject to federal tax, no tax is paid on the commission income reported by the IC-DISC.
- The IC-DISC pays dividends to its shareholders that are taxed at the qualified dividend rate of 15% creating a permanent 20% tax savings on the amount of the commissions paid by the exporter.
A company with $10 million of export sales can save $80,000 of taxes annually by using this structure. The calculations are as follows:
Total Export Sales $10,000,000
Commissions Paid to IC-DISC at 4% $400,000
Tax on Commission at Ordinary 35% Rate $140,000
Tax on Commission at Qualified Dividend Rate
Utilized on IC-DISC Dividend Distributions $60,000
Total Annual Savings: $80,000
Calculating the commission using 50% of related taxable income could generate an even greater savings.
In today’s competitive international environment, U.S. companies need to avail themselves to all opportunities to reduce costs. The tax savings generated by an IC-DISC present a great opportunity. In addition to taking advantage of them now, keep an eye on where tax rates are going in 2012 to see how IC-DISC can help you in the future.