Over the last few years, U.S. taxpayers who export have seen their U.S. tax benefits curtailed. First, Congress was required to repeal the Foreign Sales Corp. regime. Subsequently, they were required to repeal the legislation that created the Extraterritorial Income Exclusion (EIE).
However, U.S. exporters should be aware that the program Congress initially created to provide an export incentive, the Interest Charged Domestic International Sales Corporation (IC-DISC), is still in existence. The recent implementation of a 15 percent tax rate on corporate dividends makes the IC-DISC worth looking into.
An exporter is allowed a deduction for the commission paid to the IC-DISC at the exporter’s ordinary tax rate but the IC-DISC shareholder is taxed on the resulting dividend at the 15 percent rate. Assuming a maximum 35 percent corporate tax rate, the tax savings can reach approximately 20 percentage points.
A brief history of the IC-DISC
The DISC provisions were enacted into law in 1971. In 1984, the rules were modified to comply with a European Community request, and the IC-DISC was created. At the same time, the FSC provisions were added to the tax code. The FSC provisions allowed for an exemption from U.S. income tax, whereas the DISC provisions only allowed for a deferral of U.S. income tax, and interest was charged on the deferral. Thus, the FSC became the preferred export entity in most cases, and the IC-DISC was used in only limited circumstances.
What is an IC-DISC?
The IC-DISC, in most cases, is no more than a paper entity, a U.S. corporation that is paid a commission on export sales of the related supplier (i.e., the exporter). The commission paid to an IC-DISC is generally the greater of:
- 50 percent of the net profits, or
- 4 percent of the gross receipts (but not more than 100 percent of the net profits) on exports of products that are manufactured, grown or extracted in the United States.
The products must be manufactured, grown or extracted in the United States by a person other than an IC-DISC, and they must be held primarily for sale, lease or rental for direct use, consumption or disposition outside the United States. Up to 50 percent of the fair market value of the export property can be attributable to foreign content.
An IC-DISC must also meet the following requirements.
- It must be a domestic corporation
- At all times, it must have at least $2,500 in capital
- It must have only a single class of stock
- It must file timely elections
- It must meet a 95 percent qualified export asset test and a 95 percent qualified gross receipts test
An IC-DISC is not subject to U.S. income tax. It is more like a partnership, LLC or s-corporation in that its shareholders are subject to U.S. income tax on their share of the IC-DISC’s income.
The exporter, its shareholders, its management, its employees, family members or any combination thereof can own the IC-DISC. The IC-DISC can be used to generate incentive bonuses for management or employees, or facilitate succession planning, for example. Alternatively, the funds accumulated in the IC-DISC can be distributed to the shareholders and loaned or contributed back to the exporter if the cash is needed.
The IC-DISC regime provides U.S.-based exporters an opportunity to decrease their U.S. taxes on export profits by up to twenty percentage points.
Max Koss, Certified Public Accountant, is a director of international tax with Moore Stephens Doeren Mayhew. Moore Stephens Doeren Mayhew is an independent member firm of Moore Stephens International Limited, one of the world’s leading consulting and accounting networks. Moore Stephens Doeren Mayhew, located in Troy, Michigan, is a regional accounting and consulting firm providing a complete range of international tax, accounting, financial, business and consulting services. Contact Koss at [email protected] or (248) 244-3013.
