IC-DISCs: A Tax Incentive for U.S. Exporters
Thousands of companies benefit from an IC-DISC every year, but many exporters still do not take advantage of this beneficial tax incentive.
An IC-DISC is available for companies that export goods manufactured in the United States, provide engineering or architectural services for construction projects outside the United States, or lease or rent property used by the lessee outside the United States.
How does it work?
An IC-DISC creates tax savings by converting a portion of the taxpayer’s ordinary income into qualified dividend income, taxed at lower rates.
There are many options available when using an IC-DISC. One common example is:
- Company ownership establishes a separate legal entity that makes an IC-DISC election (IC-DISCs are considered tax-exempt entities and do not pay tax on their commission income).
- The exporting company pays a commission to the IC-DISC.
- The IC-DISC then distributes the commission proceeds to the owners as a dividend.
The result is that the commission deduction reduces the ordinary income of the exporting company (usually taxed at rates between 35%-39%) while the dividend income is taxed at lower qualified dividends tax rates of 20%-23.8%. This creates a form of tax rate arbitrage which results in tax savings for the owners.
Reduced income tax liabilities are not the only benefit an IC-DISC can provide for businesses. Businesses that have qualified export sales and use an IC-DISC can receive:
- Significant tax rate reduction
- Safeguard against double taxation
- Increased capital for export expansion
- Estate tax planning flexibility
- Management incentive flexibility
In its basic form, the IC-DISC is a fairly straightforward tax planning tool; however, IC-DISCs can be quite complex as taxpayers strive to maximize the commission and evaluate the best ownership structure.
There are safe harbor rules to determine the IC-DISC commission. Generally, the commission is based on:
- 4% of export gross receipts
- 50% of export sales net taxable income
In addition, taxpayers can apply the rules separately to each export transaction or to groups of related product transactions. The safe harbor pricing rules can actually result in more than a dozen ways to determine the IC-DISC commission, so it is usually a very complicated calculation to arrive at the best answer. This complex analysis is often where an advisor can provide significant value.
Tax Savings Illustration
- Owner Z forms IC-DISC, sister company to Exporter A.
- Exporter A has foreign sales of $5,000,000.
- Using the basic 4% method, the IC-DISC commission would be $200,000.
- Exporter A pays $200,000 commission to IC-DISC and deducts the commission at normal tax rates (as high as 39.6% if a pass-through entity). In addition, Owner Z receives $200,000 dividend income from the IC-DISC.
- Tax savings = $31,600 (top rate of 39.6%, less dividend rate of 23.8%, multiplied by commission)
Note that the example is based on a 4% commission. Applying the safe harbor rules to each transaction could yield a greater benefit.
Requirements / Flexibility
There are some simple but very specific requirements to meet when establishing an IC-DISC. Additionally, there is a great amount of flexibility in how it can be structured to meet each taxpayer’s needs.
John E. Jenkins?>
Robert M. Burak?>
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