IC-DISC Update for VALET Members

Transcription

1 IC-DISC Update for VALET Members Bill Major, CPA Partner International Tax October 16, 2014

2 Learning Objectives 1) Explain what an IC-DISC is. 2) The IC-DISC tax benefit is tied to the differential between qualified dividend rates and the ordinary income tax rates. Please explain. 3) What types of businesses are eligible to take advantage of these tax savings? i.e. LLCs, LPs, C Corporations? 4) What tax savings can a company expect from having an IC-DISC? 5) When should a company form an IC-DISC?

3 Learning Objectives 6) Does the exporter have to hire an outside company or can their accountant do the IC-DISC? 7) Are there tax saving opportunities other than IC-DISCs for exporting companies? 8) What qualifications must companies meet to take advantage of the tax savings? 9) What can the Qualified Export Receipts include? 10) What is included in the Qualified Export Assets?

4 Learning Objectives 11) What are the steps in setting up an IC-DISC? 12) Please comment about situations where it does NOT make sense to form an IC-DISC. 13) Does the possibility of tax reform affect IC-DISC? 14) Any other questions you may have.

5 1) Explain what an IC-DISC is.

6 How does a company and its owners save federal tax with an IC-DISC? IC-DISC Myth IC-DISCs are tax shelters. If I use an IC- DISC, it means an automatic audit, right? IC-DISC Reality Tax regulations formerly exempted IC-DISCs from being considered tax shelters. In practice, companies export first, then use IC-DISCs. They don t form an IC-DISC and then start exporting.

7 How does a company and its owners save federal tax with an IC-DISC? Owners The IC-DISC is a paper company that has limited substance. Customers do not need to know that the operating company has an IC-DISC. IC-DISCs do not require office space, employees, or tangible assets. Any company or individual domestic or foreign can be a shareholder of an IC-DISC. Operating Company IC-DISC Owners Operating Company IC-DISC

8 2) The IC-DISC tax benefit is tied to the differential between qualified dividend rates and the ordinary income tax rates. Please explain.

9 How does a company and its owners save federal tax with an IC-DISC? The Operating Company deals directly with customers, just as it always has. Customers Owners The maximum amount of the taxdeductible commission is set by tax law and is determined with reference to the taxable income derived from the Operating Company s export transactions. Deduction against hightaxed income Operating Company IC-DISC Low-Taxed Dividend Income IC-DISCs do not pay federal tax. Dividends from IC-DISCs to individuals qualify for tax rates that are lower than rates that apply to ordinary income. Customers Operating Company Owners Low-Taxed Dividend Income IC-DISC Deduction against high-taxed income

10 How does a company and its owners save federal tax with an IC-DISC? The commission expense reduces income taxed at higher, ordinary rates IC-DISC pays no federal tax The dividends paid by the IC- DISC to individuals, S Corps, trusts or estates are taxed at lower capital gain rates. Customers Deduction against hightaxed income Customers Owners Operating Company IC-DISC Owners Low-Taxed Dividend Income Low-Taxed Dividend Income Operating Company IC-DISC Deduction against high-taxed income

11 3) What types of businesses are eligible to take advantage of these tax savings? i.e. LLCs, LPs, C Corporations?

12 Does it matter how my business is organized for tax purposes? There is a potentially applicable IC-DISC structure for any business that has qualifying export sales: Domestic LLCs, S Corporations or partnerships Domestic C corporations U.S. or foreign individuals U.S. or foreign trusts (not taxed as associations) Foreign LLCs or partnerships Foreign corporations

13 Does it matter how my business is organized for tax purposes? The IC-DISC is a paper company that has limited substance. Customers do not need to know that the operating company has an IC-DISC. IC-DISCs do not require office space, employees, or tangible assets. Any company or individual domestic or foreign can be a shareholder of an IC-DISC. Operating Company Owners Operating Company IC-DISC Owners IC-DISC

14 Does it matter how my business is organized for tax purposes? IC-DISC Myth Response The $10 million limitation means larger companies aren t allowed to have IC- DISCs. The $10 million limitation applies only to how much income an IC-DISC can accumulate and its shareholders can defer from taxation. There is no limit on how much the IC- DISC can earn and distribute right back out to its shareholders as dividends.

15 Does it matter how my business is organized for tax purposes? IC-DISC Myth Response Foreign-owned companies cannot have IC-DISCs. Granted, there are technical tax issues involving U.S. and foreign tax laws and how they interact with treaties. Out-of-the-box thinking about global structures often yields interesting alternatives that sidestep these technicalities.

16 Does it matter how my business is organized for tax purposes? IC-DISC Myth Response Our bankers won t allow us to have an IC-DISC because they don t want to see more cash leaving the company. When you look at the entire picture, it often turns out that less cash will leave the company because the overall tax of the company and its owners will be reduced. Any IC-DISC structure can be tweaked to ensure that dividends from an IC-DISC have to be put back into the Operating Company.

17 4) What tax savings can a company expect from having an IC-DISC?

18 Example Calculation of Permanent Tax Savings Export Sales 2,000,000 Less: Cost of Goods Sold Export Sales ( 1,000,000) Gross Margin 1,000,000 Less: Related SG&A Expenses ( 500,000) Export Net Income 500,000 IC-DISC commission (greater of): 50% of export net income (50% of $500,000) 250,000 4% of export sales (4% of $2,000,000) 80,000 IC-DISC commission expense deducted from ordinary income 250,000 Federal tax savings 39.6% 99,000 IC-DISC corporate-level tax Federal Exempt IC-DISC dividend 250,000 Federal tax cost (20% + 3.8%) ( 59,500) Net permanent federal tax savings = Reduction of tax on ordinary income 99,000 Federal tax on dividend income (59,500) = 39,500

19 5) When should a company form an IC-DISC?

20 When does it make sense to form and operate an IC-DISC? When the tax permanently saved exceeds: the relatively small cash cost to form, implement and maintain, plus the soft cost of taking away resources devoted to other things

21 When does it make sense to form and operate an IC-DISC? Rule of Thumb: $200,000 in annual pre-tax net income from export sales

22 6) Does the exporter have to hire an outside company or can their accountant do the IC-DISC?

23 7) Are there tax saving opportunities other than IC-DISCs for exporting companies?

24 Tax Savings Other Than IC-DISC? Three tax topics often go hand in hand for companies operating in the Technology, Life Sciences, Manufacturing and Distribution sectors IC-DISC DMD R&D Credit If your company is claiming the benefits of any one of these incentives, why isn t your company claiming the benefits associated with the other two incentives?

25 8) What qualifications must companies meet to take advantage of the tax savings?

26 Qualifications Customers Owners Operating Company All of the tax law qualifications pertain solely to the IC-DISC, not to the exporter forming the IC-DISC: Deductions against hightaxed income IC-DISC Low-Taxed Dividend Income 95% of receipts test (Question 9) 95% of assets test (Question 10) Must be a C corporation formed under State or DC law Must be capitalized for $2,500 Must have only one class of stock Must make timely election

27 9) What can the Qualified Export Receipts include? 95% of the IC-DISC s own total receipts throughout the course of the IC-DISC s entire year must consist of Qualified Export Receipts

28 Qualified Export Receipts Include Commissions earned by the IC-DISC that are based on the Operating Company s profits from permitted activities that qualify for IC-DISC benefits. Owners Customers Interest Income on IC-DISC Working Capital Deductions against hightaxed income Operating Company Low-Taxed Dividend Income Interest Income on Producer s Loans made by the IC-DISC to Exporters IC-DISC

29 What activities qualify for IC-DISC benefits? One of three tests: Manufacturers Qualify! Substantial Transformation Substantial operations and activity is considered manufacturing or production within the meaning of the relevant industry 20% Conversion Cost Safe Harbor Substantial Contribution

30 What activities qualify for IC-DISC benefits? Some U.S. Components Qualify! IC-DISC Myth Response "Our products are merely a component of a larger product made outside the U.S. and sometimes that product is imported back to the U.S. We don't qualify." Products that are shipped outside of the U.S. that are component parts of another product can qualify even if the component returns to the U.S. for products to be used or consumed in the U.S. Suppliers to the auto industry.

31 What activities qualify for IC-DISC benefits? Indirect Exporting Qualifies! IC-DISC Myth Response "We are a manufacturing company, but we do not export our products. Our customers or distributors are the ones who export. We don't qualify." Manufacturers who sell to U.S. companies that ultimately export the products may qualify e.g., manufacturer of chemical products that are ultimately exported by their customer/distributor.

32 What activities qualify for IC-DISC benefits? Distributors Qualify! IC-DISC Myth "Our company is a distributor and we do not manufacture any products. We don't qualify." IC-DISC Reality Distribution of U.S. made goods that are eventually consumed or used outside the U.S. qualifies for IC-DISC benefits.

33 What activities qualify for IC-DISC benefits? Software can Qualify! IC-DISC Myth Response "We are a software company and export incentives do not apply to us. We don't qualify. Software that is downloaded from a server in the US by a Company outside the US or software licensed for reproduction outside the U.S. may qualify.

34 What activities qualify for IC-DISC benefits? Engineers and Architects can Qualify! IC-DISC Myth Response "We perform our engineering services in the U.S. relating to construction projects. We don't qualify." Engineering and architectural services performed inside or outside the U.S. qualify if they are in connection with an actual or proposed foreign production or construction project.

35 What activities qualify for IC-DISC benefits? Equipment Leasing Qualifies! IC-DISC Myth Response U.S.-manufactured goods/products that are "We merely lease the product for leased for use outside the U.S. eventual use outside the U.S. We by a third party can qualify. don t qualify." The goods/products can be new, used or refurbished.

36 What activities qualify for IC-DISC benefits? Agriculture or Certain Mining Qualifies! IC-DISC Myth "We don't manufacture. We grow or extract our product. We don't qualify." Response Crops grown or certain minerals extracted in the U.S. and exported may qualify. Cannot claim IC-DISC where percentage depletion is taken.

37 What activities qualify for IC-DISC benefits? State tax return apportionment data. Ship to state is identified as foreign. Lots of sales to the states of Florida or Texas going specifically to Miami or Laredo. Do you have sales to foreign customers? Canada and Mexico are considered foreign countries, despite NAFTA. Foreign customers includes related parties and subsidiaries. Does your product get distributed by others to foreign locations? Is your product made, produced, grown or extracted in the U.S.? Do foreign parties license software from you? Do you provide services to foreign customers? Construction projects occurring outside the U.S. Related to products made in the U.S. but used outside the U.S.

38 10) What is included in Qualified Export Assets? 95% of the IC-DISC s total assets as of the end of the IC-DISC s year must consist of Qualified Export Assets

39 Qualified Export Assets Necessary working capital Commissions Receivable that are Paid off within 60 days after the IC-DISC s year-end Based on a reasonable estimate that was recognized by the IC-DISC s year-end.

40 Qualified Export Assets Producer s Loans Accumulated IC-DISC Income Growth in Inventory plus Net Fixed Assets plus R&D expenses for year Cumulative Inventory plus Net Fixed Assets plus R&D expenses Private Export Funding Corporation commercial paper. Foreign International Sales Corporation stock.

41 11) What are the steps in setting up an IC-DISC?

42 How much work is it to have an IC-DISC? IC-DISC Myth IC-DISC Reality Using an IC-DISC takes too much work. All our accounting systems have to be changed. Customers are going to question why they are suddenly dealing with a new company." The most work an IC-DISC will ever likely take is during its first year. The IC-DISC s only customer is usually the existing operating company. Invoices that customers will receive will continue to come from the operating company and look no different just because there s an IC-DISC in the background. Customers will make payments to the operating company in the same manner as before.

43 How much work is it to have an IC-DISC? (First Year) Decide on ownership Form a corporation under State (or D.C.) law. One class of shares Capitalize for $2,500 minimum 90 days from incorporation: Submit IRS Form 4876-A to elect IC-DISC status Year-end Conduct annual meeting Decide on form & timing of dividend Make adjusting journal entries on IC-DISC s and Operating Company s books After year-end Finalize computations of export income and IC-DISC commission Prepare and submit IC-DISC tax return

44 How much work is it to have an IC-DISC? (Following Years) Decide on ownership Form a corporation under State law. One class of shares Capitalize for $2,500 minimum 90 days from incorporation: Submit IRS Form 4876-A to elect IC-DISC status Year-end Conduct annual meeting Decide on form & timing of dividend Make adjusting journal entries on IC-DISC s and Operating Company s books After year-end Finalize computations of export income and IC-DISC commission Prepare and submit IC-DISC tax return

45 What do I have to do now to qualify for IC-DISC benefits? Decide on structure Capitalize corporation minimum $2,500. Adopt agreements relating to commissions, shareholders, etc. IC-DISC distributes dividends to shareholders? IC-DISC distributes remaining dividends to shareholders 10 2 Form a new corporation under State law, obtain FEIN Limit = 90 days Submit IRS Form 4876A To elect IC- DISC status Annual Board Meeting Exporters pay Commission to IC-DISC? Limit = 60 days Exporters pay remaining Commission to IC-DISC Limit = 8 ½ months 11 Submit 1120 IC-DISC tax return Year End of IC-DISC

46 12) Please comment about situations where it does NOT make sense to form an IC-DISC.

47 IC-DISCs change the amount of tax on income without changing the amount of income being taxed. Therefore, IC-DISCs don t make sense when: Net (pre-tax) income from exports is under $200,000 per year Income is already being taxed at a low effective rate. The ultimate taxpayer has no taxable income.

48 13) What does the prospect of tax reform mean for IC-DISC?

49 What does the prospect of tax reform mean to IC-DISCs? IC-DISC Myth Response Aren t IC-DISCs going away at the end of 2014? No, IC-DISCs aren t going away. Consider the history of the repeated expiration and extension of the R&D credit. The qualified dividend rate has already survived for two extensions. The last effort to repeal IC-DISCs altogether in 2007 died pretty quickly. The S Corp Association, the National Association of Manufacturers, and the Club for Growth are all behind export tax incentives.

50 What does the prospect of tax reform mean to IC-DISCs? IC-DISC Myth Response The WTO made us get rid of DISCs, then FSCs, then the extraterritorial income exclusion. The WTO is going to make us get rid of the IC-DISC, too. The WTO is on record stating the interest-charge feature of the IC- DISC prevents the deferral from taxation from being an illegal export subsidy.

51 Contact Information Bill Major, CPA Partner, International Tax Services Cherry Bekaert LLP 1075 Peachtree St NE Suite 2200 Atlanta, GA (404)