IC-DISCs let you realize tax savings from exported products
Are you looking for a way to save your manufacturing company some income taxes this year? Does a portion of your revenue come from exports? Then you may want to consider forming an Interest Charge–Domestic International Sales Corporation (IC-DISC), the last surviving exporting incentive for U.S. manufacturers.
The pluses
While other exporting incentives have evaporated over the years, the IC-DISC remains intact. In fact, the currently low qualified-dividend tax rate makes IC-DISCs especially attractive.
An IC-DISC is relatively easy to set up and administer because it’s a “paper” corporation without bricks and mortar, employees or tangible assets. It’s simply a substantial tax-savings vehicle for U.S. exporters that manufacture products here.
IC-DISC in action
To reap the IC-DISC benefits, your manufacturing company (or the shareholders) first forms an IC-DISC. Your company then pays the IC-DISC a tax-deductible commission to sell its products abroad. Several methods can be used to calculate the commission amount; however, under the two most common methods the maximum commission you can pay is either the greater of 50% of export net income or 4% of export gross receipts. The IC-DISC is a tax-exempt entity and therefore pays no U.S. income tax on the commission income, though it must file a tax return.
When the IC-DISC pays a dividend to its shareholder(s), the commission income is currently taxed at the qualified-dividend tax rate of 15%. The tax benefit equals the difference between the tax saved due to the deduction for the commission and the tax paid on the dividend.
For example, the American Widget Co., an S corporation with $2 million in export net income and $25 million in export gross receipts, sets up an IC-DISC. American Widget pays the maximum commission of $1 million. American Widget’s shareholders deduct the commission from their ordinary income, saving them 35% of the commission amount in taxes (assuming they’re in the top tax bracket), or $350,000.
The shareholders later pay income tax on the $1 million in dividends received from the IC-DISC at the qualified dividend rate of 15%, or $150,000 in taxes. By using an IC-DISC, the shareholders save $200,000 in taxes ($350,000 in tax savings due to the commission deduction – $150,000 in taxes paid on the dividend).
Meeting the requirements
An IC-DISC must be a U.S. corporation, keep separate books and records, and satisfy a number of technical requirements, such as:
- Electing to be treated as an IC-DISC for tax purposes,
- Maintaining a minimum capitalization of $2,500,
- Having a single class of stock,
- Meeting a qualified export assets test, and
- Meeting a qualified gross receipts test.
To pass the qualified export assets test, the IC-DISC’s tax basis in qualified export assets (plus certain other assets) must be at least 95% of its adjusted basis in all assets. Qualified export assets are assets:
- Manufactured, produced, grown or extracted in the United States,
- Held primarily for sale, lease or rental for direct use, consumption or disposition outside the United States, and
- Whose value isn’t more than 50% attributable to imported materials.
To pass the gross receipts test, at least 95% of the IC-DISC’s gross receipts must consist of commissions for qualified export asset property.
Is it worth your while?
It’s important to keep in mind that, as of this writing, the 15% dividend rate is set to expire after 2010, although the special tax rate may only be increased rather than eliminated altogether. (Check with your tax advisor for the latest information.) The IC-DISC also allows taxes to be deferred until the IC-DISC pays the dividend, but there is an “interest charge” designed to largely offset this deferral.
There are “buy fees” for having a tax professional set up and administer an IC-DISC, along with annual compliance costs. So, before setting up this kind of corporation, you’ll want to make sure that your tax savings exceed your filing expenses. Your tax advisor can work up some numbers for you.
Sidebar: Should you buy equipment or software before year end?
You may want to consider it. Manufacturers who act soon may be able to take advantage of two tax breaks extended by the American Recovery and Reinvestment Act of 2009 (ARRA): higher Section 179 expensing limits and 50% bonus depreciation.
Business owners can use Sec. 179 expensing to deduct (rather than depreciate over a number of years) the cost of purchasing such items as new equipment, furniture and off-the-shelf computer software. ARRA extended the $250,000 limit (up from $133,000 before the act) through calendar year 2009 or a business’s fiscal year that begins in 2009.
You can claim the election only to offset net income, not to reduce it below zero. The tax break begins to phase out dollar for dollar when total asset acquisitions for the tax year exceed $800,000 (up from $530,000 before the act).
The other break, 50% bonus depreciation, offers a special allowance for certain new property, generally if acquired and put into service in 2009. This amount is equal to 50% of the property’s adjusted basis. Eligible property includes:
- Tangible property with a recovery period of 20 years or less,
- Computer software,
- Water utility property, and
- Qualified leasehold improvement property.
Bonus depreciation isn’t subject to any asset purchase or net income limits, so businesses ineligible for Sec. 179 expensing can benefit. And if you qualify for Sec. 179 expensing, you can take bonus depreciation on asset purchases in excess of the $250,000 Sec. 179 limit. But keep in mind the $800,000 acquisition limit or you could lose part of your Sec. 179 deduction.
Kevin Heyde, CPA
Partner, International Tax Services Director
