IC-DISC TAX SAVINGS FOR EXPORTERS An overlooked tax break that could be your big break Reduce Current & Future Taxes Interest Charge Domestic International Sales Corporation (IC-DISC) 1
What Is An IC-DISC? An IC-DISC is a tax-exempt, domestic paper corporation set up to receive commissions on your company s export sales. It must have its own bank account, keep separate accounting records and file U.S. tax returns. But it need not have an office, employees or tangible assets, nor is it required to perform any services. An IC-DISC reduces your tax liability by converting a portion of your export income, which is taxable at ordinary income rates as high as 40.5%, into qualified dividends generally taxed at 23.8%. 2
IC-DISC History Started 1971: Revenue Act of 1971 establishes Domestic International Sales Corporation (DISC) Changed in 1984: Interest Charge-DISC in response to European Economic Community The Jobs and Growth Tax Relief Reconciliation Act of 2003: Qualified dividend tax rate reduced to 15% creates tax break American Taxpayer Relief Act of 2012: Qualified dividend rate extended indefinitely at 15% - 23.8% depending on income bracket while raising top line tax rate to 39.6% Applies to all types of taxpayers (Sole proprietors, Partnerships, LLCs, S corporations and C corporations) IRC Code Sections: 992, 993, 994, 995, 996 3
IC-DISC Basics An IC-DISC is a paper corporation, the related operating company continues with business as usual Tax benefits commence once an IC-DISC is established Tax benefits are calculated annually Available to all exporters whether a manufacturer, producer, grower, software developer or distributor Qualified export property must have at least 50% U.S. content Must be a U.S. taxpayer to benefit from an IC-DISC. It does not matter what type of company the operating company is. It can be a: Sole Proprietorship Partnership LLC S Corporation C corporation 4
IC-DISC Basics How do you qualify to save taxes through an IC-DISC? 1. Ultimate beneficiary or shareholder should be a U.S. Taxpayer. 2. Operating Company must be profitable. 3. Operating Company must export items of 50% or more U.S. content to locations outside of the U.S. whether directly or indirectly, or provide engineering or architecture services on construction projects outside of the U.S. 5
IC-DISC Basics IC-DISC Taxes and its Shareholders An IC-DISC is not subject to corporate tax (IRC 991) Money paid out of an IC-DISC is treated as a Qualified Dividend at a rate from 15% - 23.8% If the exporting entity is a flow-through entity, tax savings are typically up to 17% If the exporting entity is a C corporation, it can still benefit from the differential in rates and income is shielded from double taxation Income can be deferred within the IC-DISC 6
Qualified Export Sales Qualified Export Sales Sale, exchange or other disposition of export property Lease or rental of export property used outside of U.S. Related and subsidiary services (engineering and architectural services; managerial services for furtherance of exports) Sales made to U.S. distributors 50% or more of the content must be U.S. derived Do not need to be the ultimate producer or ultimate exporter 7
Qualified Export Sales Proof of Export Copy of sales invoice Copy of export bill of lading Certificate of carrier showing delivery outside the U.S. Certificate of lading by customs officer of foreign country If no custom s officer, written statement of recipient Shipper s export declaration filed with Bureau of Customs Other proof: invoices, receipts, payment, etc. 8
IC-DISC Commission The tax savings are based upon a commission agreement between the operating company and the IC-DISC The Operating Company pays the IC-DISC this commission or Export Management Fee based on the following: 50% of the Qualified Export Sales pre-tax net income (50% method), or 4% of the Qualified Export Gross Receipts 9
IC-DISC Benefit Example Using 50% Method 10
IC-DISC Commission Method Foreign sales 20,000,000 Cost of goods sold (16,000,000) Gross Margin 4,000,000 Selling, general and administrative costs (3,000,000) Export sales net income 1,000,000 IC-DISC commission (greater of): 50% of export net income 500,000 4% of export gross receipts 800,000 IC-DISC commission 800,000 Federal tax savings (39.6%) 316,800 IC-DISC dividend 800,000 Federal tax cost (23.8%) 190,400 IC-DISC net tax savings 126,400 11
IC-DISC Commission Method Neither the 4% gross receipts method nor the 50% method may be applied in a way that causes, in any taxable year, a loss to the related supplier. 12
Qualified Export Sales Operating Company Qualifies For IC-DISC Operating Company IC-DISC Shareholder(s) IC-DISC Commission Sales Qualified Dividend Export Customers 13
Qualified Export Sales Supplier & Operating Company Qualify For IC-DISC U.S. Supplier Supplier IC-DISC Operating Company IC-DISC Shareholder(s) IC-DISC Commission Sales Qualified Dividend Export Customers 14
Qualified Export Sales Supplier, Operating Company & Distributor Qualify For IC-DISC U.S. Supplier Supplier IC-DISC Operating Company IC-DISC Shareholder(s) Qualified Dividend IC-DISC Commission Sales U.S. Distributor Distributor IC-DISC Export Customers 15
Qualified Export Sales Operating Company with Foreign Supplier DOES Qualify For IC-DISC Foreign Supplier Operating Company (> 50% Value Added) IC-DISC Shareholder(s) IC-DISC Commission Sales Qualified Dividend Export Customers 16
IC-DISC Ownership If the Operating Company is a Flow-Through Entity, potential owners of the IC-DISC are: Individuals Trusts The Operating Company Other Flow-Through Entities If the Operating Company is a Non-Flow-Through Entity, potential owners of the IC-DISC are: Individuals Trusts Flow Through Entities 17
IC-DISC Incorporation 1. State of Incorporation 2. Incorporation Requirements 3. Incorporation Documents 4. Agreement(s) between Operating Company and IC-DISC 18
IC-DISC Incorporation Incorporation Requirements 1. Establish Corporation 2. Single Class of Stock 3. IC-DISC Election (Form 4876-A) 4. Capitalization of IC-DISC of at least $2,500 5. Timing of Incorporation 6. Separate books from Operating Company 19
IC-DISC Incorporation Other Documents Related To The IC-DISC 1. Incorporation Documents: Bylaws, Articles of Incorporation, Shareholder Agreements, etc. 2. Agreement(s) between Operating Company and IC-DISC: Sales Agent Agreement (Commission Agreement) 20
IC-DISC Ownership Pass-through Entities (S-Corporations, LLCs and Trusts): Dividends pass through the corporation to the shareholders and are taxed at the Qualified Dividend tax rate of 15% - 23.8%. Individual Shareholder(s) Payment To IC-DISC Reduces Taxable Income at 39.6% Pass-through Exporting Company (Related Supplier) IC-DISC Qualified Dividend Taxed At 15% - 23.8% 21
IC-DISC Ownership C-Corporations: Avoid double taxation by having the IC-DISC owned by individual shareholders. Individual Shareholder(s) Qualified Dividend Taxed At 15% - 23.8% C-Corp Exporting Company (Related Supplier) Payment To IC-DISC Reduces Corporate Taxable Income at 34% IC-DISC 22
IC-DISC Ownership Publicly Traded Operating Companies Only real option is to have the IC-DISC owned by the Operating Company and use it as a tax deferral vehicle. Large / Changing Shareholder Bases at Operating Company Flow-Through Entity optimal to have Operating Company own IC-DISC and use it as tax savings vehicle C-Corp Either use as deferral vehicle or have individual shareholders own the IC-DISC and change ownership accordingly 23
IC-DISC Ownership Estate Planning: IRA IRA Ownership Of IC-DISC Accumulated IC-DISC income taxed at individual rates 15-39.6% when distributed Assets in IRA invested tax-free Roth IRA distributions not taxed to beneficiaries Cases pending on whether excise tax on excess contributions is applicable 24
IC-DISC Ongoing Items Annual Maintenance and Items To Adhere By 1. 95% qualified gross receipts test 2. 95% qualified export asset test 3. $2,500 capital at all times 4. Timely payment of commissions 5. 1120 IC-DISC and applicable Schedules 6. Maintain IC-DISC books 25
Tax Return & Filings 1. IC-DISC Election (Form 4876-A) 2. 1120 IC-DISC & Attached Schedules 3. Form 8404 4. Applicable State Filings 26
Identify Opportunities 1. Where does the company sell its products? Where are projects located if architecture and engineering firms? 2. Does the company sell to third parties or distributors? 3. Are the products exported by the company made in the U.S. or is 50% or more of the content derived from the United States? 4. Was the company qualified for the Extraterritorial Income Exclusion in years past? If so, it likely qualifies for an IC-DISC. 5. In order to capture tax benefits with an IC-DISC, the IC-DISC must already be formed. So be proactive. 27
Ways IC-DISC Consultants Can Help IC-DISC Structural Analysis & Consulting Incorporation & Agreements IC-DISC Compliance IC-DISC Calculations and Tax Benefit Maximizing Analysis Ongoing Consulting and Advisory Services Year-End Planning Year-End Analysis and Tax Benefit Maximization IC-DISC Tax Returns & Forms 28
Contact Please feel free to contact us with any further questions. Clarke, Snow & Riley, LLP 25 Newport Avenue Extension Quincy, MA 02171 TEL (617) 773-9944 FAX (617) 773-9292 www.csrk.com Thomas Clarke tc@csrk.com Kamran Khan kk@csrk.com 29