Utilizing An IC-DISC to Unlock Greater Export Revenue
Firms exporting overseas may be unaware of an incentive in the U.S. tax code that can noticeably reduce tax liability and free up more revenue. An Interest Charge-Domestic International Sales Corporation (IC-DISC) is a provision that allows some or all of taxable income relative to export sales to be taxed at a lower rate. Since the early 1970s, U.S. tax law has allowed DISCs to exist in some form as an incentive for U.S. companies export products overseas or expand their export operations.
Our Guide to IC-DISC is a free resource that explains everything you need to know about using an IC-DISC to improve your cash flow.
How Does an IC-DISC Work?
An IC-DISC works by reducing an exporters tax liability by allowing some or all taxable export income to be taxed at a lower rate as a qualified dividend, rather than as ordinary income.
While a company carries out all of its export operations as usual, an IC-DISC is an intermediary company that serves as a sales commission agent for the exporter. An IC-DISC is a separate legal entity, and firms seeking to create an IC-DISC must obtain approval from the IRS and must also maintain separate financial operations for the IC-DISC such as bank accounts, accounting structures, and tax reporting.
An IC-DISC is particularly attractive for small-to-medium sized U.S. based exporters, who struggle with tight margins and a highly competitive overseas environment. The extra cash flow generated by an IC-DISC can be a valuable tool to increase profits and improve overall business operations.
Case Study: COMPANY X Easily Creates an IC-DISC to Improve Business
Company X, a small professional services firm delivering services both domestically and overseas, set up and IC-DISC in 2014. Working with a certified public accountant, Company X determined which of its 2013 export revenues would qualify as export gross receipts under Internal Revenue Code 199.
Structured with an S Corporation shareholder, Company X and its CPA confirmed its qualifications and its tax benefit calculations – which rest on the difference between the qualified dividend tax rate on the annual dividend versus the ordinary tax rate of the shareholder on the annual commission payment.
Company X formed the new corporate entity in Delaware to act as its registered agent and the new company elected to be treated as an IC-DISC under IRS 4876-A (Election To Be Treated as an Interest Charge DISC.) The new IC-DISC opened a bank account with $2,500 and established a legal Commissions Agreement between it and Company X. Set-up costs incurred were under $1,500.
Annually, Company X determines which sales qualify as export sales and uses a simplified 4% method to calculate income. The IC-DISC exists using journal entries with its own set of accounting records and files an annual federal tax return and a Delaware franchise tax return. Annual costs incurred are under $1000. Company X finds that the process to set up and maintain an IC-DISC are not complicated or burdensome for a small business.
What Are the Benefits of an IC-DISC?
For example, if an S corporation company similar to Company X above earns $2 million in net taxable international income and pays a commission of 50% or $1 million of that amount to an IC-DISC, it reduces its reported taxable income by that amount.
The company’s shareholders report this income (now reduced to $1 million from $2 million) on their individual tax returns. Assuming the shareholders are in the top tax bracket – and taxed at 29.6% (the top rate of 37% multiplied by 80%*) – the commission to the IC-DISC resulted in a total federal tax reduction of $296,000 for the shareholders.
The $1 million commission paid to the IC-DISC is taxed to the IC-DISC’s owners – when paid or deemed paid – as a qualified dividend at the 23.8% rate, resulting in a tax of $238,000. The difference between paying ordinary income tax rate (29.6% noted above) on $1 million and the qualified dividend rate for the IC-DISC results in a tax savings of $58,000.
*This 80% assumes the full benefit for pass-through entities of the newly enacted 20% Qualified Business Income Tax deduction (see Internal Revenue Code Section 199A)
How to Start Using an IC-DISC
Nearly any firm that exports overseas may qualify for an IC-DISC. Manufactured products as well as agricultural and horticultural products qualify. Software and professional services such as engineering and architectural designs are also covered. A firm that manufactures a good that is included in a product that is subsequently exported can also qualify.
As with any tax incentive, a number of legal details have to be considered. Eligibility requirements mainly include (but are not limited to): companies must be privately owned; exported products must contain at least 50 percent U.S. content (based on total market value); and a company must directly or indirectly export more than $3 million annually.
To determine if your company is eligible and for more details on utilizing an IC-DISC, a number of sources exist. The EXIM Bank has resources such as briefing pages and Webinars, and can provide lists of experts than can help a company get the ball rolling on an IC-DISC strategy.
Tax regulations and registration requirements are subject to change, so a consultation with a CPA or tax attorney with experience in IC-DISCs is strongly suggested. Securitas works with business advisors such as the teams at Kreischer Miller and Baker Tilly, who can provide clients with more detailed information on IC-DISCs and their benefits.
In addition to offering comprehensive export credit insurance solutions, the team at Securitas can also put new clients in touch with current and former clients who have utilized an IC-DISC to their advantage.
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