IC-DISC: Exploring one of the most underutilized parts of the tax code.
The current economic situation has brought international trade to the forefront of discussion. This provides a perfect opportunity to review one of the most underutilized tax strategies tailored to generate large savings for U.S. exporters, the IC-DISC. By utilizing what is called an interest charge domestic international sales corporation (IC-DISC) to sell products abroad, U.S. exporters can lower their tax bill by paying the capital gains rate on income earned from international sales rather than the personal or corporate tax rate. In general, the tax code offers this as a tax rate arbitrage strategy to take advantage of the spread between capital gains and income tax rates. Let’s examine how it works.
The IC-DISC strategy is one of the many ways the government attempts to promote competitiveness of U.S. companies and goods across the world. However, there are a number of legal guidelines and tax structures that must be followed to take advantage of this opportunity. The process is laid out as follows:
1- An IC-DISC is established by the exporter as a closely held sister corporation and maintains its own bank account and financial records, and files its own tax returns.
2- The IC-DISC entity realizes all qualified export receipts (QERs) for goods sold abroad. These goods must be primarily manufactured in the U.S.
3- The company pays a commission to the IC-DISC, which is the greater of 4% of the DISC’s gross receipts or 50% of its net income on overseas sales. This commission is tax deductible for the exporter entity, and the IC-DISC entity is tax exempt.
4- The IC-DISC pays a dividend, which is taxed at the capital gains rate. The dividend can be paid to shareholders of the parent company or of the IC-DISC*
*One of the dynamic things about IC-DISC is that recipients of the dividend can either be shareholders of the IC-DISC or the exporting entity. This provides significant benefits for estate and succession planning.
ABC Med, an S-corp and an exporter of medical equipment, utilizes an IC-DISC to sell products abroad. The IC-DISC generates $1.5 million in QERs with $1 million in qualified cost of goods generating a net income of $500,000. ABC pays a deductible commission of $250,000 to the IC-DISC leaving it with a taxable income of $250,000. This gets distributed to the shareholder of ABC Med as a dividend. A total tax of 23.9% (maximum short-term capital gains rate plus net investment income tax of 3.9%) is paid on these dividends resulting in a $158,750 tax bill. If an IC-DISC was not used in this situation, ABC’s shareholders would have had to pay $198,000 on the net income from exports (assuming shareholders are taxed at the maximum rate). Thus, by using an IC-DISC, ABC’s shareholders were able keep 20% more of their cash from overseas sales.
Obviously, the benefit here is a lowered tax bill on sales abroad. However, establishing an IC-DISC and parent company structure that allows for maximization of this benefit and full compliance with all tax code requirements requires a nuanced understanding of these laws. Companies looking to pursue this opportunity should consult with a tax expert that can execute the work needed to establish all the necessary entities and processes.
If an IC-DISC strategy sound like it would makes sense for your company, please reach out to the tax experts at Diligentiam. Our CPAs will work with your company to establish the process needed to form and maintain an IC-DISC in a manner that can help meet the financial goals of your shareholders.