By Luis Ramirez, CPA, Principal
Looking for a tax break? An interest-charge international sales corporation (IC-DISC) can be a powerful tax-savings opportunity for many companies exporting products and certain services. An IC-DISC is a domestic corporation that engages in foreign sales and exporting activities. The laws for IC-DISCs have been in place for many years as a means to promote U.S. business activities globally. IC-DISC’s are relatively easy to structure with very little, if any, change required to your business. Essentially, the IC DISC is invisible to your customers but the tax savings can be substantial.
IC-DISC laws allow the U.S. exporter to convert a portion of the export net income, which can be taxable at ordinary income rates as high as 41% in today’s environment, into qualified dividends generally taxed at 23.8%. The end result is a permanent reduction in federal tax!
What Qualifies for Export Incentives?
- U.S. Exporter that sells or leases export property (software counts);
- Property produced, manufactured, grow or extracted in the U.S.; or
- Held primarily for sales, lease or rental for direct use, consumption or disposition outside the U.S.
Example Using S Corporation
Assume an S corporation has $5M in qualifying export sales and $2M in net export income on those sales. If the company has an IC-DISC, it can pay commissions to the IC-DISC equal to the greater of 50% of net income or 4% of the export gross receipts. In this case, the maximum is 50% of net income, $1M.
If we treat the $1M as a dividend, the results are:
- The S corporation takes an ordinary business deduction for the commission paid to the IC-DISC of $1M which yields a deduction for the shareholders of 41% in today’s high tax bracket;
- The IC-DISC received $1M in commission income that is NOT taxable under the IC-DISC laws;
- The IC-DISC pays a dividend to the S corporation shareholder that is taxed at the qualified dividend rate of 20% plus the 3.8% tax under the Affordable Care Act; and
- Tax savings is a net 17.2% on the $1M or $172,000.
C corporations can obtain permanent tax savings for payments that would otherwise be made as dividends. If a C corporation makes regular dividend payments and has sufficient earnings from export activities, the commission earned on the IC-DISC in a sister corporation can be used to fund the dividend payments. Thus, the otherwise non-deductible dividend payment can be converted to a tax-deductible commission expense to the C Corporation.
How can ASL Help?
- Determine if your export sales qualify under the law;
- Quantify the federal tax benefits (IC-DISCs are not allowed under California law);
- Annual monitoring and maintaining separate books and records; and
- File the appropriate tax returns and election.