IC-DISC Compliance: Exporter Challenges in the Federal Tax Break

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1 FOR LIVE PROGRAM ONLY IC-DISC Compliance: Exporter Challenges in the Federal Tax Break THURSDAY, DECEMBER 21, 2017, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 IC-DISC Compliance Dec. 21, 2017 James Loizeaux, Managing Director, Global Tax Services CliftonLarsonAllen, Minneapolis Robert J. Misey, Jr., Shareholder Reinhart Boerner Van Deuren, Chicago & Milwaukee

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

IC-DISCs: Tax Savings for Exporters Presented by Robert Misey, Esq.

6 History of Export Benefits Congress enacted the Domestic International Sales Corporation (DISC) regime to try to stimulate exports Due to complaints, Congress enacted the Foreign Sales Corporation (FSC) regime to replace the DISC regime, but allowed the IC-DISC to remain The ETI regime excluded a portion of an exporter's income The 2012/2013 Tax Act guaranteed IC-DISC savings The IC-DISC has survived the current tax bills All Rights Reserved Robert Misey

9 Introduction to IC-DISC (cont.) Taxation of an IC-DISC and its shareholders An IC-DISC is not subject to corporate tax When the IC-DISC pays a dividend, its owners will pay tax at a 20% rate If the manufacturing entity is a flow-through entity, the tax savings are 20 percentage points If the manufacturing entity is a C corporation, the tax savings are 28 percentage points All Rights Reserved Robert Misey

12 The Interest Charge in IC-DISC US U.S. tax with acc IC-DISC Inc.: $8.5 million U.S. tax without acc IC-DISC Inc.: $5 million Deferred U.S. tax: $3.5 million AFR: 1% Interest: $35,000 Manufacturer acc IC-DISC Inc.: $10 million IC-DISC U.S. F export customers All Rights Reserved Robert Misey

14 The Tests to Qualify as an IC-DISC (cont.) 95% of its gross receipts must constitute qualified export receipts Sales of export property Rents for use of export property outside the United States Services related to exports Engineering or architectural services for construction projects abroad, and Commissions All Rights Reserved Robert Misey

19 The Tests to Qualify as an IC DISC 95% of the assets of the IC-DISC must be qualified export assets Temporary investments Export property Accounts receivable Loans to producers Shares of a related foreign export corporation All Rights Reserved Robert Misey

Example 5 Working Capital as Qualified Export

HKCo RFEC widgets $500 same country foreign customers other

23 Example 8 --Avoid Subpart F Income With a Related Foreign Export Corporation US S commission IC-DISC US widgets $400 F HKCo RFEC widgets $500 same country foreign customers other country export customers All Rights Reserved Robert Misey

24 Qualification as Export Property The property must be manufactured in the U.S. by a person other than the IC-DISC The export property must be held primarily for use outside the U.S. The property must have a maximum of 50% foreign content All Rights Reserved Robert Misey

25 Qualification as Export Property (cont.) Property is manufactured within the U.S. if either U.S. conversion costs incurred constitute 20% of the cost of goods sold There is a substantial transformation in the United States, or The operations in the U.S. are generally considered to constitute manufacturing All Rights Reserved Robert Misey

Example 11 Generally Considered to Constitute Manufacturing US US blank CDs USAco USAco

test requires being held for use outside

Example 12 Satisfying the Destination Test

35 Qualification as Export Property (cont.) The Maximum of 50% Foreign Content Requirement No more than 50% of the fair market value of export property may be attributable to the fair market value of imported articles The fair market value of the foreign content is determined by its dutiable value All Rights Reserved Robert Misey

Example 16 Foreign Content > 50% FMV W US PAPco

37 Determining the IC-DISC Benefit The commission is the greater of 4% of the qualified export receipts 50% of the combined taxable income, or The arm's-length amount determined under the transfer pricing principles of Section All Rights Reserved Robert Misey

38 Implementation Considerations for the IC-DISC Incorporate the IC-DISC before the export sales begin Analyze the export sales don't forget indirect sales and Canada Draft the commission agreement Prepare and timely file the Form 4876-A that elects IC-DISC status Prepare a manual that contains guidelines and a checklist/calendar All Rights Reserved Robert Misey

About Robert Misey Robert Misey is Chair of the International Department for Reinhart Boerner Van Deuren and Chair of the International Tax Committee for the

A graduate of the law schools at Vanderbilt University and Georgetown University, Robert is a former trial attorney for the Internal Revenue Service Chief Counsel

39 About Robert Misey Robert Misey is Chair of the International Department for Reinhart Boerner Van Deuren and Chair of the International Tax Committee for the American Bar Association. A graduate of the law schools at Vanderbilt University and Georgetown University, Robert is a former trial attorney for the Internal Revenue Service Chief Counsel (International) in Washington, DC. He is also the author of the books A Practical Guide to U.S. Taxation of International Transactions and Federal Taxation: Practice and Procedure. Rob can be reached at either or or rmisey@reinhartlaw.com All Rights Reserved Robert Misey

40 Compliance and Reporting for IC-DISCs Part III Presented by: Jim Loizeaux Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor CliftonLarsonAllen LLP WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING

2017 CliftonLarsonAllen LLP James D. (Jim) Loizeaux Managing Director Global Tax Services, CliftonLarsonAllen LLP 612-397-3204 james.loizeaux@claconnect.

41 2017 CliftonLarsonAllen LLP James D. (Jim) Loizeaux Managing Director Global Tax Services, CliftonLarsonAllen LLP Jim is a national practice leader in the Global Tax Services group for CliftonLarsonAllen. He has over 25 years of international tax experience focusing on cross-border transactions, reorganizations, repatriation of earnings and exports. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 41

42 2017 CliftonLarsonAllen LLP Pricing Rules An IC-DISC can act as a buy-sell entity or a commission-based entity. The commission or transfer price between the IC-DISC and related supplier is calculated under one of the three following methods: 4 % gross receipts 50% combined taxable income (CTI) Section 482 The commission or transfer price is the greater of the allowable method WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 42

43 2017 CliftonLarsonAllen LLP Pricing Rules Under both the 4% gross receipts and 50% CTI methods, the DISC does not need to perform any economic functions or have any employees. Under both the 4% gross receipts and 50% CTI methods, the DISC can increase its commission by 10% of its export promotion expenses (EPEs) EPEs include general administrative and selling expenses, certain freight paid to U.S.-flagged carriers, packaging costs, and design and label costs for export products incurred by the DISC. (Note: EPEs paid by a related party can qualify, if a contract existed between the related party earmarking the EPEs for the DISC before the transaction took place.) WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 43

44 2017 CliftonLarsonAllen LLP Pricing Rules The pricing method chosen may be based export on transactions using one of the following approaches: Aggregate Transaction by transaction Product groupings WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 44

45 2017 CliftonLarsonAllen LLP Pricing Rules When utilizing the CTI method, overhead costs generally are allocated and apportioned between export and domestic sales, based on detailed rules [Reg ]. If the profit margin on export products is less than profit margin on worldwide sales of the same products, then marginal costing rules may be applied to allocate only marginal or variable costs against export receipts to compute marginal costing CTI (MC CTI). Overall, the CTI method generally produces a larger benefit than the gross receipts method, when exports have a greater-than-8% profit ratio. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 45

46 2017 CliftonLarsonAllen LLP Sample Commission Calculation Related Supplier Income Statement Before IC DISC Commission Total Domestic Exports Domestic Sales COGS Gross Profit SG&A Taxable Income Profit Margin 25% WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 46

47 2017 CliftonLarsonAllen LLP Sample Commission Calculation continued DISC Commission Calculation Method 4% of Export Sales 50% of CTI Export Sales COGS (50) Gross Profit 50 SG&A (25) Combined Taxable Income (CTI) 25 Total Commission WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 47

48 2017 CliftonLarsonAllen LLP Grouping Transactions Calculations are generally to be done on a transaction-by-transaction basis. Regulations permit grouping of transactions along product or product lines. Grouping can be beneficial when the groups have different characteristics. Example: ABC Company produces multiple products, including Products A and B. Product A is a high-profit product line with limited export sales. Product B is a low-profit line but has high exports. If the two can be combined, then the high profit may raise the permissible commission paid for the AB group. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 48

49 2017 CliftonLarsonAllen LLP Grouping Transactions (Cont.) WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 49

50 2017 CliftonLarsonAllen LLP Marginal Costing Reg. Sec Permits taxpayers to use marginal costing to determine permissible DISC profit under the 50% method Requires that the DISC is treated as seeking to establish or maintain a foreign market A DISC is seeking to establish or maintain a foreign market if the CTI for the specific transaction or group of transactions is lower than the CTI calculated by applying the overall profit percentage from the product or product line to the qualifying export receipts. In effect, the DISC meets this requirement if the profit determined using marginal costing is higher than the full costing profit. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 50

51 2017 CliftonLarsonAllen LLP Marginal Costing (Cont.) WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 51

52 2017 CliftonLarsonAllen LLP No Loss Rule (Reg (e)(1)) No loss rule is a limitation on the DISC s income if the computation of CTI results in a loss. If CTI is a loss, CTI is limited to $0 See schedule P, Part I, Section A, Line 3 There is an exception to the no loss rule that allows the computation of a commission under the 4% gross receipts method where the overall profit percentage ( OPP ) is positive limited to 4% See Schedule P, Part I, Section C, Line 22 WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 52

53 2017 CliftonLarsonAllen LLP No Loss Rule continued DISC Commission Calculation (e)(1)(i) Method 4% of Export Sales CTI Export COGS (75) Gross Profit 25 Overhead (40) Net Income 0 Total Commission 0 0 WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 53

54 2017 CliftonLarsonAllen LLP No Loss Rule Application of Special Rule (Reg (e)(1)(ii)) OPP = Taxable income of product or product line for domestic and export sales Total gross receipts of sales Taxable income = 100 Gross receipts = 400 OPP = 25% Export receipt = 100 4% method = 4 Special rule = 25 ($100 x 25%) Commission = 4 (lesser of 4% method or special rule) WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 54

55 2017 CliftonLarsonAllen LLP Summary of Tax Filings Initial IC-DISC election is made on Form 4876-A within 90 days of the start of the taxable year (must be signed by all shareholders). A Form 1120 IC-DISC is required to be filed annually on or before the 15 th day of the ninth month following the close of the tax year. Attached will be Schedule K, Shareholder s Statement of IC-DISC Distributions (indicates actual and deemed distributions that are taxable) WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 55

56 2017 CliftonLarsonAllen LLP Summary of Tax Filings A Form 8404 must be filed by all IC-DISC shareholders on or before the original due date of their tax returns (no extensions are permitted). Form 8404 requires any deferred interest-related costs to be paid (estimated tax payments are not required on a quarterly basis). Deferred interest is calculated on hypothetical tax based on ordinary rates, not qualified dividend rates. (Section 995(f)(2)(A)(i)) Form 8404 anticipates that estimates are likely needed, and amended procedures are outlined in form instructions. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 56

58 Interest Charge Domestic International Sales Companies: Common & Alternative Structures Part IV Presented by: Jim Loizeaux Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor CliftonLarsonAllen LLP WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING

59 2017 CliftonLarsonAllen LLP Flow Through Entities This is the most common and easiest structure. Cash travels between the S Corporation and IC-DISC The shareholder receives Reduced ordinary income Increased qualified dividends As reported on a Schedule K-1 S Corp or Partnership IC-DISC WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 59

60 2017 CliftonLarsonAllen LLP C Corporations This structure gets additional income to a C Corp shareholder when wages are at a max or the shareholder is not active in the business. The C Corporation receives an ordinary deduction for commissions paid. The shareholder receives a Form 1120-IC- DISC Schedule K-1 reporting the qualified dividends. C Corp IC-DISC WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 60

61 2017 CliftonLarsonAllen LLP Officer Bonus Plan Officer This structure gets additional income to a business s officers. The C Corporation receives an ordinary deduction for commissions paid. The officers receives a Schedule K from the IC-DISC reporting the qualified dividends. Structuring consideration: C Corp IC-DISC - Commissions paid cannot be direct replacement for incentive compensation the officers would otherwise be eligible to receive under other corporate bonus or incentive plans WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 61

62 2017 CliftonLarsonAllen LLP Foreign Owner This structure gets tax favored dividends to a foreign parent. The C corporation receives an ordinary deduction for commissions paid. (Rather than no deduction for a dividend paid) The foreign owner *may* receive a dividend subject only to withholding tax. Structuring Considerations: C Corp Foreign Corp IC-DISC - Benefit based on treaty override of Section 996(g) - Foreign shareholder must file a Form 1120F with a Form DISC also reports dividends on a Form 1042-S - Foreign country taxation of the dividend must be addressed WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 62

63 2017 CliftonLarsonAllen LLP Generation Transfer This structure transfers income to an owner s children or grandchildren Rev. Rul C Corp, S Corp or Partnership Childre n IC-DISC WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 63

64 Interest Charge Domestic International Sales Companies: IRS Audit Issues Part V Presented by: Jim Loizeaux, CliftonLarsonAllen LLP Robert Misey, Reinhart Boemer Van Deuren S.C. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor CliftonLarsonAllen LLP WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING

65 2017 CliftonLarsonAllen LLP IRS Audit Issues Until recently, the IRS has not seemed to focus on indepth audits of IC-DISCs Many audits focused on formation or qualification issues Recently, the IRS is starting to audit more complex IC-DISCs WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 65

66 2017 CliftonLarsonAllen LLP Formation and Qualification Issues A standing IRS Information Document Request asks for documentation related to formation and qualification issues Support for valid IC-DISC election Formation issues include documentation regarding the formation of the corporation and capitalization Qualification issues include separate books and records Best Practice: Separate checking account to show all transactions, in-andout of the IC-DISC WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 66

67 2017 CliftonLarsonAllen LLP Common Compliance Pitfalls The DISC must make an initial estimate of the commission at the end of the year, and the related supplier must pay the commission within 60 days of the close of the year [Reg (e)(3)(i)]. Reasonable estimate requires at least 50% accuracy Payment should generally be in cash to avoid noncompliance risk True-up commission requires payment in 90 days. WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 67

68 2017 CliftonLarsonAllen LLP Common Compliance Pitfalls Failure to clear DISC receivables by year end resulting in DISC disqualification under the 95% asset test Failure to property capitalize the DISC Failure to comply with corporate formalities Failure to maintain separate books and records WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 68

69 2017 CliftonLarsonAllen LLP Other Issues Commission Expense Computations Proper support should be in your file to support the Schedule Ps included with 1120-IC-DISC Cost accounting records should support the gross margins Work papers should support the SG&A computations WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 69

70 2017 CliftonLarsonAllen LLP Other Issues Coordination with DPAD Computations Both DPAD and DISC commissions should rely on the methodology found in Reg (see Reg (d)(i)) This regulation requires that specifically identified costs of sales be deducted from classes of sales SG&A must be allocated using a reasonable methodology WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 70

71 2017 CliftonLarsonAllen LLP Other Issues Non-standard structures Treaty-based IC-DISCs IC-DISCs in Roth IRAs Generation transfers Critical to document the legal support and for any non-standard structures WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 71

72 2017 CliftonLarsonAllen LLP What the IC-DISC Shareholder Should Understand Legislative history How the benefit is computed Different methods to compute the commission Form over substance The DISC is fragile Cost to requalify the DISC Lack of IRS guidance IRS audit Questionable practitioners WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 72

73 2017 CliftonLarsonAllen LLP Pigs get fat Hogs get slaughtered Other Words of Wisdom WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING 73

IC-DISC: Compliance Challenges in the Federal Tax Break for Exporters

IC-DISC: Compliance Challenges in the Federal Tax Break for Exporters TUESDAY, OCTOBER 21, 2014, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours. To earn credit