The Federal Export Incentives Offered IC-DISCs Provide Businesses with Significant Tax Savings
Export incentives are assistance provided by governments to help businesses sell products in foreign markets. The only federal export incentive currently being offered in the U.S. provides tax savings to companies utilizing interest charge domestic international sales corporations (IC-DISCs).
An IC-DISC is organized by the shareholders or partners of an exporting business that operates as an S corporation, limited liability company, partnership, or closely-held C corporation. The exporting business then pays commissions to the IC-DISC that are deductible for federal income tax purposes. The IC-DISC, itself, is treated as a federally tax-exempt entity.
As a general rule, the U.S. has adopted a substance-over-form approach to income tax law that disfavors artificial structures with no business purpose and often views them as tax-avoidance mechanisms. However, IC-DISCs are an exception to the rule because they are allowed to operate as tax-exempt C corporations without any employees and earn commission income without needing to perform any services or participate in any sales.
Eligible Exporting Businesses
Under the Internal Revenue Code, three types of business are usually eligible for IC-DISC export tax incentives:
- Direct Exporters. Companies that directly export the goods it manufactures.
- Indirect Exporters. Companies that manufacture components used in exported goods or that resell goods manufactured in the U.S. The manufacturers of parts shipped along with the exported product may also be eligible.
- Architectural and Engineering Services. If the services are for the construction of buildings outside of the United States they may be eligible for export tax incentives.
Tax Treatment of an IC-DISC
IC-DISCs are C corporations that enjoy a federal tax exemption. To take advantage of IC-DISC tax treatment, within 90 days of its first taxable year the corporation must file a Form 4876-A, Election to be Treated as an IC-DISC. The election must be signed by all of the shareholders as of its effective date and will remain in force until the election is revoked.
The exporting business pays commissions to the IC-DISC based on the foreign sales of products produced, manufactured, extracted, or grown in the U.S. and then deducts the commission from its ordinary business income. As a tax-exempt entity, the IC-DISC pays no federal tax on the commissions it receives.
The IC-DISC usually distributes the commissions it receives as dividends to its shareholders. The dividends paid to shareholders who are individuals or pass-through entities are taxed at the qualified dividend tax rate, which is generally more favorable than the rate for ordinary income.
Export Commission Calculations
Exporting businesses have a number of options when calculating the commissions it will pay over to the IC-DISC. Three of the most popular are:
- 50% of its combined taxable income or export profits;
- 4% of its qualified export receipts (subject to export profit limitations); and
- The amount earned by a buy-sell IC-DISC that has its own operations and employees.
Shareholders may also defer up to $10 million in annual commission using the IC-DISC, but the exporting business must pay interest at a nominal rate on the deferred revenue attributed to the IC-DISC.
Rules for IC-DISCs
IC-DISCs are required to maintain their own business records and maintain a separate bank account from the exporting business. Additionally, they are only allowed to issue a single class of stock and the IC-DISC’s outstanding stock must maintain a par or stated value of at least $2,500.
The IC-DISC need not have the same shareholders as the exporting business and can be utilized to offer a benefit to key employees or as a tool for estate and succession planning. Additionally, an IC-DISC may have foreign shareholders, so long as the shareholders agree that any distribution will be income effectively connected with a U.S. permanent establishment.
Dividends paid to shareholders from an IC-DISC are usually considered to be foreign-sourced income, which makes IC-DISCs attractive to U.S. shareholders who have passive foreign tax credit carryovers.
Code Accounting can Help with IC-DISCs
To learn more about implementing an IC-DISC and the possible tax savings for your export business, contact the experienced professionals at Code Accounting. Our staff has the experience needed to assist clients in forming IC-DISCs and maximize the tax benefits they can provide. At Code Accounting, we are passionate about assisting Bay Area businesses with implementing effective tax-saving strategies tailored to their specific needs.
To learn more about how Code Accounting can help, give us a call at 510-706-2877, or send an email to: firstname.lastname@example.org.Tags: customs taxes, Exports, tax incentives
Categorised in: Foreign Transactions, Government
This post was written by Sean Allaband