03.16.2015

Tax Benefits Using IC-DISC

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What is an IC-DISC?

IC-DISC is the last remaining export tax incentive available to US exporters and it is supported in both Houses of Congress and the White House. IC-DISC stands for Interest Charge Domestic International Sales Corporation. The rules and requirements governing the IC-DISC are found in IRC §§ 992 – 997. These provisions have been a part of the code since 1972 and have been accepted by the GATT and the WTO since 1984.

Tax Benefits Using IC-DISC

Permanent Tax Rate Reduction: IC-DISC owned by an S Corporation, individual shareholders and/or key employees of US operating company with qualified export sales. IC-DISC could also be owned by a Traditional IRA or a Roth IRA (although Roth IRA ownership is a “listed transaction”) of an individual shareholder / key employee.

• Effective federal tax rate reduction from 39.6% to 23.8% (20% CG tax + 3.8% NIIT) on IC-DISC profits:

o Commission to IC-DISC deducted by ExportCo at 39.6% tax rate
o IC-DISC not taxable
o IC-DISC distributions to Shareholders are qualified dividends taxed at 20% capital gains rate plus 3.8% net investment income tax rate (possible tax exemption if Roth IRA used)

Temporary Tax Rate Reduction: IC-DISC owned by US operating company with qualified export sales, or by corporate parent of US operating company.

• Option to defer tax on profits earned on export receipts of $10 million or less:

o Profits on export receipts in excess of $10 million must be distributed annually by IC-DISC
o Shareholders pay interest on tax deferred profits at treasury bill rate
o Rate reduction is permanent if IC DISC shareholder is an S Corporation

Target Profile

• Closely held (e.g., individual shareholders) US businesses organized as sole proprietors, partnerships, LLCs, S corporations, or C corporations.
• Generates qualified export receipts from:

o Sales, leases, subleases, or rental of export property manufactured, produced, grown or extracted in the United States
o Services related to sales and leases of export property (warranty, maintenance; repair; installation; transportation [including insurance], provided its cost is included in the sale/rental price, or, if separately stated, is paid by the DISC or its principal)
o Sales, exchanges, or other dispositions of qualified export assets
o Engineering or architectural services for construction projects located outside the US (except those related to exploration for oil)

• Annual export sales of at least $1 Million;
AND/OR
• Net taxable income derived from export sales of at least $200,000.

Sample Benefit

 

Maximizing the Benefit

• IC-DISC rules allow the use of various pricing methods in addition to the two previously mentioned to achieve the greatest IC-DISC commission income possible.
• The IC-DISC rules provide approximately twelve (12) different pricing methods that can be used to optimize the IC-DISC commission income.
• The rules permit the exporter to compute the IC-DISC commission on an aggregate basis, product family, product line, product, recognized industry or trade usage or even by transaction.
• Generally, the margins of the exporter will dictate which pricing methods are used.
• The exporter can optimize the IC-DISC commission by ignoring loss sales.
• The exporter can optimize the IC-DISC commission by choosing to group certainly high margin sales from certain low margin sales.
• The exporter can also apply special “marginal costing” rules to optimize the IC-DISC commission. These rules allow the exporter to only include “direct costs” such as direct material and direct labor and exclude fixed costs and S,G & A for purposes of optimizing the IC-DISC commission.
• The rules also allow the exporter to substitute its combined domestic and export profitability if higher to help bolster its export profitability for purposes of optimizing the IC-DISC commission.
• The exporter has considerable flexibility in how it allocates and apportions expenses (i.e., S,G & A).
• Some expenses if not directly related to export sales (e.g., expenses of a domestic sales force) can be excluded entirely for purposes of optimizing the IC-DISC commission.
• There are special rules for certain expenses such as interest, research and development, state and local taxes, charitable contributions, and a few others. There can be tremendous flexibility and opportunity in allocating or apportioning these expenses away from export sales for purposes of optimizing the IC- DISC commission.

Three tests must be satisfied:

1. The property must be manufactured, produced, grown, or extracted in the US by a person other than an IC-DISC.
2. The property must be held for sale, lease or rental, in the ordinary course of trade or business by, or to, an IC-DISC for direct use, consumption or disposition outside the US.
3. Not more than 50% of the fair market value of the property can be attributable to articles imported in the US (consider US articles sent offshore for assembly and brought back; where is value from – US design, US articles, foreign manufacture/assembly).

1.1. Numerator is value of imported article when imported to US;
1.2. Numerator is direct labor costs (under unicap principles) performed outside the US;
1.3. Denominator is value (normally sale price) of export property when exported;
1.4. Numerator may not exceed 50% of denominator (export sale price).
1.5. Safe harbor: 20% of costs (labor, materials, etc.) must be US labor or factory burden. Taxpayer does not have to be a manufacturer. Distributors qualify.

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