Companies that manufacture products within the United States and export abroad may derive tax benefits from the use of an Interest-Charge Domestic International Sales Corporation (IC-DISC). The IC-DISC may be particularly beneficial for small to midsize privately held businesses and their owners.
The IC-DISC is a separate legal corporation that is able to defer taxation on up to $10 million of export revenues each year, providing certain requirements are met. The IC-DISC, itself, is not subject to federal income taxes on export sales income, though a Form 1120-IC-DISC is required annually.
The more commonly used form of an IC-DISC is a commission IC-DISC (with the other form being a buy/sell IC-DISC). In the commission structure, the IC-DISC functions as a commission agent selling products (almost entirely) outside of the United States (one requirement of an IC-DISC is that at least 95% of its revenues are export receipts). In this structure, the IC-DISC charges a sales commission to the U.S. manufacturer, which receives a deduction at ordinary tax rates.
The annual IC-DISC income is calculated using one or a combination of three methods; 4% of qualified export receipts, 50% of the combined taxable income, or an arm’s-length amount based on transfer pricing principles. To maximize the commission benefit, a transaction-by-transaction analysis is often performed to calculate the greatest commission amount allowed for each separate export sale.
Because the IC-DISC is not a tax-paying entity, there is no tax on the commission income. The shareholder(s) of an IC-DISC are taxed on either the actual or deemed distributions from the IC-DISC in the form of a dividend. The deemed dividend to the U.S. shareholder(s) is calculated based on the IC-DISC’s taxable income on export revenues in excess of $10 million (the taxable income on the first $10 million of export receipts are tax-deferred until actually distributed to the shareholder(s)). The deferred tax liability on the undistributed earnings is subject to an interest charge (currently less than 1% annually).
For certain IC-DISC owners, the different tax characterization of the dividend and commission results in a federal tax rate spread of approximately 16% for taxpayers in the highest individual tax brackets. The dividend to the shareholder(s) is taxed at approximately 24% (20% dividend rate + 3.8% net investment income tax rate), and the benefit of the commission deduction is at the ordinary rate of 39.6%.
The implementation and use of an IC-DISC is a tax strategy that can result in both temporary and permanent tax benefits. That’s right, tax deferral and tax savings. Sounds too good to be true, but it is a legitimate tax structure.
The IC-DISC is not a viable option for everyone, but it should be considered for U.S. manufacturers with significant overseas sales. If your company thinks that IC-DISC may be an option, contact the Schneider Downs International Tax Advisors.