The IC-DISC: An Underutilized Tax Savings Provision

Part of a series on issues related to Manufacturers, Distributors and International Trade

There is an increasingly wide divide between Democrats and Republicans on a multitude of issues. However, both parties agree that exports are a key to economic growth.

Last year, President Obama announced his goal to double U.S. exports by 2015, and Republican leaders indicated their desire to work with the President to expand trade to key allies. To encourage exports, the President issued a National Export Initiative that focuses on helping small to mid-sized U.S. businesses export their products and services.

The extension of the qualified dividend rates through 2012 also provides U.S. exporters with the opportunity to save taxes by establishing an Interest-Charge Domestic International Sales Corporation (IC-DISC).

Yet many export companies that could benefit from the tax savings of an IC-DISC fail to do so. According to some estimates, only about 6,000 businesses–a small portion of those that qualify—take advantage of the tax savings of an IC-DISC.

Capitalizing on these tax savings could give Missouri export companies a leg up on their competition. A key to increasing profitability is working smarter not just harder. Less taxes means more money that can be injected into the business to fuel growth and increase profitability.

Candidates for an IC-DISC

Privately held C-Corporations and pass through entities, such as S-Corporations, partnerships and LLCs, that could benefit from the tax savings of an IC-DISC include:

• Manufacturers and distributors of U.S. manufactured products with more than 50% U.S. content and a destination outside of the U.S.,
• Architectural and engineering firms with projects outside of the U.S.,
• Software developers of computer software that is licensed for reproduction outside of the U.S.,
• Agricultural and mineral producers that export products outside the United States, and
• Lessors of new or used U.S. made products to third parties for use outside of the U.S.

How an IC-DISC Works

A U.S. export company sets up a separate domestic corporation that makes an election to be treated as an IC-DISC. Most IC-DISCs are “paper” companies. An IC-DISC is not required to have employees or office space, but it must maintain its own books and records.

Once the IC-DISC is established, the export company can pay the IC-DISC commission on qualifying export sales. There are several allowable methods that can be used to calculate the commission. Usually, the best result is obtained by using the greater of 4% of the company’s qualified export gross receipts or 50% of its taxable export income or a combination of these two methods.

Tax Savings Generated

The commission paid to the IC-DISC is deductible, which results in less income being taxed at ordinary income tax rates. The IC-DISC is not a taxable entity and therefore does not pay federal tax on the commission it receives. The IC-DISC distributes its income to its shareholders as qualified dividends that are taxed at the preferential capital gains tax rate (currently 15% maximum).

By establishing an IC-DISC, the taxation of export profits is reduced from an effective rate of 35% to an effective rate of 15%. The result is a tax savings on an unlimited amount of export profits of up to 20 percentage points, which is equal to the difference between the ordinary income tax rate (currently up to 35%) and the qualified dividend rate (up to 15%).

Comparison of Taxes of a Pass-Through Entity With and Without an IC-DISC

The substantial tax savings generated by an IC-DISC make it worthy of consideration.

Posted by Attorney Marcia S. Orgill. Orgill concentrates her practice in the area of business and personal taxation—especially complex domestic and international tax strategies.