Did you realize the US tax code has perks for US businesses whose product ends up overseas?
If you’re exporting goods without an IC-DISC (an “interest charge domestic international sales corporation”), you’re likely paying more income tax than necessary. By implementing this powerful tax planning strategy, you could realize significant tax savings on your foreign sales.
What is an IC-DISC?
In simple terms, I think of it similarly to if you had a salesperson overseas who was representing your company and for every sale they generate you agree to pay them 4% of the gross sales amount. The amount you pay that salesperson would be tax deductible to the operating/exporting company. Now, your IC-DISC is essentially that salesperson. You deduct the commission paid to the IC-DISC and then distribute the commission to yourself.
What are the potential benefits of an IC-DISC?
For individuals, directly or indirectly through pass-through entities such as limited liability companies or S corporations, an IC-DISC may reduce their tax rate on export profits from the ordinary income tax rate (maximum of 37.9% for 2021 including the extra Medicare tax for earners over $250k joint) to the dividend rate (maximum of 23.8% including the new Medicare tax on investment income) – an approximate savings on tax rates of 14.1%, each year.
The federal income tax savings is typically the difference between the applicable ordinary income rate and the capital gains tax rate multiplied by the greater of 50% of the taxable income from exports or 4% of qualified gross export sales. This 50% of net or 4% of gross, whichever is higher, is the maximum amount of “commission” that can be paid by the exporting company to an IC-DISC.
What exactly is an IC-DISC entity?
An IC-DISC is a corporation formed under state law that: Has a single class of stock; Maintains a minimum capitalization of $2,500; Has qualified export receipts and a qualified exports assets; and Elects to be taxed as an IC-DISC.
If all of these requirements are met, an IC-DISC is not subject to federal (and many states, including California) income tax on commission payments received from the exporting company. Instead, the shareholders of the IC-DISC are taxed on the distribution of those payments by the IC-DISC as dividends.
Qualified Export Property
To qualify as an IC-DISC, at least 95% of its receipts must be from the sale or lease of “export property”:
- manufactured, produced, grown or extracted in the U.S. by a person other than an IC-DISC;
- held primarily for sale in the ordinary course of business for use outside of the U.S.; and
- not more than 50% of its value is comprised of imported materials.
This does not mean that 95% of the exporting company’s receipts must be from exports. It simply requires that the IC-DISC be paid by the exporting company based on export sales. Through a commission agreement between the exporter and the IC-DISC, you can ensure that the IC-DISC is paid based only on qualified export receipts.
Note that there are certain types of property that simply do not meet the definition of “export property” such as most intellectual property (patents, inventions, designs and the like) and products that deplete like oil, gas and coal.
Export property is considered “manufactured” if there is a “substantial transformation” before sale (e.g., irreversibly change the character or use of the original materials and add economical value to them, such as transforming steel rods into nuts and bolts) or the conversion costs account for at least 20% of the total cost of goods sold.
Qualified Export Sales
Qualifying export sales may be delivered in the U.S. as long as the product is ultimately delivered, used, or consumed outside the U.S. within a year of sale for use outside the U.S. Accordingly, indirect sales can qualify as a qualified export receipt. Qualified exports, however, do not include property subject to further manufacturing or other processing after the sale and before ultimate delivery outside the U.S. Often, obtaining proper documentation for “indirect sales” is critical in this area.
Qualified Export Assets
As to qualified export assets, at least 95% of an IC-DISC’s assets at the end of each year must be assets held in connection with exporting activities such as working capital, receivables and producer’s loans. Again, this is generally not a difficult requirement to meet through proper agreements among the applicable parties.
The Lack of Substance for an IC-DISC
The IRS recognizes that IC-DISCs are not required to have economic substance (e.g., have its own employees and operations)! They admit that this is a "paper" entity and it is allowed because of the desire to incentivize the export of U.S.-manufactured goods. Given that, however, you must be very careful to ensure that all legal and technical requirements are met so to qualify as an IC-DISC.
To discuss whether an IC-DISC is right for you, please contact us for advice on your particular situation!
Note: This article is intended to be a general overview and not a comprehensive analysis of IC-DISC law. Moreover, it does not constitute legal advice. The examples are provided for illustrative purposes only. There is no guarantee that this would be the tax savings for your unique facts and circumstances. Competent legal counsel should be consulted to apply the relevant legal requirements to your specific fact pattern.