Posted by David Roer, CPA
The subject of Interest-Charge Domestic International Sales Corporations (commonly known as an IC-DISC) is complex, but often worth exploring. The IC-DISC is a corporate tax remedy – one that provides U.S. exporters and manufacturers large tax incentives in order to mitigate potentially significant tax burdens. With international economic growth on the rise, it’s crucial for exporters and manufacturers to be privy to the IC-DISC concepts.
Congress created the Domestic International Sales Corporation (DISC) in 1971 to encourage U.S. exporters to help economic growth by engaging in activities. In simple terms, a U.S. exporter was allowed to allocate a portion of its export profits to a domestic subsidiary – a DISC, which per IRC Section 991 is not subject to US Corporate tax – to reduce its U.S. taxes.
How does this tax advantage work and do you qualify? First, the exporting company pays a commission to the IC-DISC based on foreign sales of products manufactured or produced within the United States (please consult your tax advisor regarding determination of the commission amount). This commission is then deducted from ordinary business income by the exporting company and acts as commission receipts received by the IC-DISC. From a kneejerk perspective, the IC-DISC receives and reports the commission income tax-free, while the exporting corporation receives a deduction at ordinary rates, at a maximum rate of 39.6%.
According to IRC section 995(b), a shareholder of an IC-DISC will treat any distributions as taxable dividend income at the favorable qualified dividend tax rate (maximum rate of 23.8% comprising qualified dividend rates and the net investment income tax). Effectively, the export company receives a deduction at the ordinary tax rate and the identical amount is paid out as a dividend, flowing through to the owners at qualified dividend rates. It is important to remember that if the IC-DISC chooses to not pay dividends to its shareholders, an interest charge – these are interest-charged DISCS – will apply to the deferred tax, usually based on Treasury Bill Rates.
To attain IC-DISC status, four criteria must be met by the Corporation – it is important that you consult your tax advisor regarding whether or not your Corporation’s facts and circumstances are applicable.
Bottom line: The IC-DISC concept is a way to secure a 15.8% direct tax benefit by merely setting up a separate corporation and adhering to the necessary rules and restrictions. While this introduction hits the highlights, the remaining IRC rules and regulations are more complex. Proactive measures such as these can result in significant tax savings.