What is an IC-DISC?
An Interest Charge Domestic International Sales Corporation, or IC-DISC, offers a significant federal income tax savings for making or distributing U.S. products for export. An IC-DISC is not a tax shelter, but creates permanent tax savings by transferring income from the exporter to the tax exempt IC-DISC through an export sales commission. At LBMC/McGuire Sponsel, our approach is designed to minimize the filing and maintenance burdens for our clients while maximizing commissions and tax savings.
How does an Interest Charge Domestic International Sales Corporation (IC-DISC) work?
An IC-DISC is a separate entity that earns a “commission” on the operating company’s export sales based on the greater of
- 50% of net income on sales of qualified export property or
- 4% of gross receipts from sales of qualified export property.
A properly executed IC-DISC isn’t taxable at the entity level. So, the operating company receives a deduction for the commission paid at ordinary tax rates and the IC-DISC pays no tax.
The IC-DISC distributes all of its profits as qualified dividends, and the owners pay tax on the dividends at more favorable capital gains tax rates. Depending on the owners’ personal income levels, federal capital gains tax rates could be as low as zero or 15% — or as high as 23.8% (the highest federal capital gains rate of 20% plus an additional 3.8% of net investment income tax).
The IC-DISC commission payment reduces the exporter’s taxable income, thus reducing tax liability by the marginal tax rate of the commission amount. An IC-DISC commission is taxed at the qualified dividends rate only when distributed to shareholders as dividends. The transfer of income to the IC-DISC creates a permanent tax rate arbitrage on the export sales commission of 15 to 18 percent.
Benefits of an Interest Charge Domestic International Sales Corporation (IC-DISC)
Beyond tax reduction, an IC-DISC can be used to:
- Increase liquidity for shareholders or businesses.
- Supply ongoing financing to reduce cost of capital. An IC-DISC is not required to distribute all commission income to shareholders. In some cases, income can be loaned back to the exporter creating tax deferment and working capital.
- Create management and employee incentives for IC-DISC shareholders.
- Create a tax-advantaged vehicle for succession or estate planning. Income can be transferred to the IC-DISC tax free and then distributed in a tax-advantaged manner to shareholders. The distribution can provide funding for buyouts, or create a vehicle to transfer wealth at reduced effective tax rates.
- Eliminate double taxation for C-Corporations and defer taxes.
IC-DISC Frequently Asked Questions
Will my customers know of the existence of an IC-DISC?
It is important to note that nothing changes for the exporting entity on a day-to-day basis. The best way to describe the existence of an IC-DISC is to think of it as if it were an internal sales agent that works entirely on commissions. When a sales agent sells a product, the exporting entity remains responsible to fulfill, invoice, and ship the order to its customers. Consequently, the exporter continues to operate its business in the same manner as if the IC-DISC were nonexistent.
If my customers find out about the IC-DISC, will they want some of the tax savings to be passed on through reduced prices?
The only individuals that will ever know about the existence of the IC-DISC is the IRS, their CPA firm, and the LBMC/McGuire Sponsel team. As mentioned above, nothing changes from the company’s operating standpoint and at no point would the supplier/commission agreement between the exporting company and the IC-DISC need to be disclosed to customers.
How much federal tax can it save?
To illustrate, let’s suppose Widgets, Inc. (a fictional S corporation) ships $2 million internationally and pays $80,000 in commissions to its IC-DISC. Assuming the owners qualify for the highest capital gains tax rate of 23.8%, they’ll owe federal tax of $19,040 on qualified distributions from the IC-DISC.
However, the owners also owe less tax on their S corporation earnings. Widgets can deduct $80,000 in commissions paid to the IC-DISC, resulting in a tax savings of $31,680, assuming that the owners are in the highest federal tax bracket of 39.6%.
The net savings is $12,640 ($31,680 – $19,040), or 15.8% of the commission charge. It’s often possible to pay a higher commission using the 50% of net export income calculation, however.
What steps are required to properly execute IC-DISC strategy?
- Form the new IC-DISC entity under state law.
- Make the IC-DISC election within 90 days of formation.
- Offer only one class of stock with par or stated value of stock of at least $2,500.
- Maintain a separate set of books and records for the IC-DISC.
Taxpayers also can establish the IC-DISC in a domicile without state income tax to eliminate the need to file state income tax returns.
The IC-DISC essentially exists for the sole purpose of running a commission calculation at the end of the year, which is returned as a qualified dividend to the shareholder. Above all, it is completely invisible to any and all customers and the exporter reaps all the tax benefits.
The Key Behind a Transaction-by-Transaction IC-DISC Calculation
In early discussions with potential clients, sales detail tends to be one of the most common hang-ups. Although the thought of collecting detailed sales information can seem like a tedious and overwhelming task, we generally see that companies already sufficiently track sales in a way that can be configured to run a transaction-by-transaction calculation.
The key behind a transaction-by-transaction calculation is in the detail provided by the client. The Code and Regulations allow us to modify the allocation of costs between domestic and export sales in an effort to either “maintain or gain” foreign market share. Thus, the general rule is the more detail we receive, the better we can model the cost allocations. Therefore, components of sales detail such as invoice number, product descriptions, product family, quantity, material cost, weight, square feet, and machine hours, provide more factors for us to model the calculation and maximize the commission expense.
Although accounting for sales can vary greatly from one company to the next, the sales detail the company currently maintains is always a great starting point. Often times this is plenty of information to run a transaction-by-transaction calculation. However, if you want to maximize your IC-DISC benefit, always remember: The more detail, the better!
- IC-DISC Audit Guide
- Form 1120-IC-DISC Interest Charge Domestic International Sales Corporation Return
- Instructions for Form 1120-IC-DISC
Potential for Big Tax Breaks for Exporters
The potential tax savings and return on investment can outweigh the costs of creating and administering an IC-DISC. If you export a significant amount of products, discuss this strategy with your tax advisor today.