The interest charge domestic international sales corporation, or IC-DISC, provides a permanent tax benefit to entities that export products that are manufactured, grown, or extracted in the United States. The idea is to provide an incentive for keeping production in the United States, as opposed to seeking cheaper costs outside the country.
This provision began as a domestic international sales corporation (DISC) only. It was enacted by Congress in 1971 and, as mentioned above, was intended to encourage domestic production and U.S. exports, thereby strengthening the economy. The original benefit was a long-term deferral of taxable income. This deferral was indefinite as long as the DISC earnings were reinvested in export operation assets and were not distributed to shareholders. The Tax Reform Act of 1984 (passed as part of the Deficit Reduction Act of 1984, P.L. 98-369) terminated all DISC elections, and the rules were modified to add an interest charge on the deferred tax of the undistributed earnings. The interest charge was to be paid to the Treasury. This was the beginning of the IC-DISC.
Other interpretations of the rules were formed with the implementation of the foreign sales corporation and the extraterritorial income exclusion, but these laws have since been repealed because they were ruled illegal subsidies by the World Trade Organization. The IC-DISC, however, grew more popular after the Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-27, which lowered the capital gains tax rates to 0%—15% and included similar rate reductions on qualified dividends. While interest on any undistributed earnings is due to Treasury, the long-term tax deferral has evolved into a permanent tax savings vehicle that is, in general, underused.
To take advantage of these benefits, an exporting organization must form a new C corporation and elect IC-DISC status. In general, an IC-DISC is exempt from federal tax on all earnings. The IC-DISC is essentially a paper entity that has no separate operations. There are two types of IC-DISCs: (1) a commission IC-DISC, discussed below, which acts as a commission agent for an exporting entity and (2) the less commonly used "buy/sell" IC-DISC, which takes title to the goods and resells them abroad.
For a commission IC-DISC, an agreement is required between the IC-DISC and the exporting entity that establishes a commission to be paid on qualifying sales. The commission is income to the IC-DISC, which is exempt from tax, and it is a deductible expense to the exporter. The commission is limited to the greater of (1) 50% of the IC-DISC's and the seller's combined taxable income from qualified export receipts plus 10% of the IC-DISC's export promotion expenses attributable to the receipts or (2) 4% of qualified export receipts plus 10% of the IC-DISC's export promotion expenses attributable to the receipts—but not more than 100% of taxable income based on the sale price actually charged.
The IC-DISC's earnings are distributed as dividends to the shareholder(s). For the individual shareholder(s), the dividend is taxed at the qualifying dividend tax rate, which could be as high as 20% plus 3.8% for the net investment income tax. Thus an individual who is taxed at the maximum tax bracket rate of 39.6% could receive a rate reduction of as much as 15.8 percentage points.
The IC-DISC scenario is available to exporting entities of all forms of business organizations, including C corporations, S corporations, partnerships, LLCs, and sole proprietorships.
There are several procedural requirements, which include:
- The IC-DISC must be a domestic C corporation;
- The IC-DISC must have at least $2,500 in capital at all times;
- The IC-DISC must have only a single class of stock;
- The IC-DISC must file a timely election;
- The IC-DISC must meet a 95% qualified export asset test;
- The IC-DISC must meet a 95% gross receipts test; and
- The IC-DISC may not be a personal holding company.
For the benefits to be worthwhile, an exporter needs to be profitable, with exports of approximately $1 million; however, the amount may vary depending on the company's gross profit. Little additional overhead or operating cost is associated with the IC-DISC (they do need to file an annual information return, Form 1120-IC-DISC, Interest Charge Domestic International Sales Corporation Return). It is a tax savings mechanism with significant permanent tax savings of up to 15.8 percentage points. There is no reason that a qualifying exporter should not take advantage of an IC-DISC.
Michael Koppel is a retired partner with Gray, Gray & Gray LLP in Canton, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or email@example.com.
Unless otherwise noted, contributors are members of or associated with CPAmerica International.