“IC-DISC” Offers Tax Savings for Exporters
If your Company earns significant income from exporting United States domestic-made products—or from engineering or architectural services on foreign construction projects—you may be eligible to form, and you should consider forming, an “Interest Charge – Domestic International Sales Corporation” (IC-DISC).
Due to its status as an IC-DISC, the IC-DISC pays NO Federal Income Taxes and reduces the Exporter’s tax liability by effectively converting a portion of the Exporter’s net export income, which is taxable at ordinary income rates as high as 40.5 percent (39.6& plus 0.9% Medicare Surtax), into qualified dividends generally taxed at 23.8 percent (20% plus 3.8% Tax on Net Investment Income).
An IC-DISC’s tax benefits are not retroactive, but rather prospective only. The tax benefits are available only for export sales made after the IC-DISC is established.
What is an IC-DISC?
A domestic “C” corporation must request and receive IRS approval to be treated as an IC-DISC for federal tax purposes. It also must maintain its own bank account, keep separate accounting records, and file United States tax returns. But it need not have an office, employees, or tangible assets, nor is it required to perform any invoicing or provide services.
Due to its status as an IC-DISC, the IC-DISC pays NO Federal Income Taxes and reduces the Related Exporter’s tax liability by effectively converting a portion of the Related Exporter’s net export income, which is taxable at ordinary income rates as high as 40.5 percent (39.6& plus 0.9% Medicare Surtax), into qualified dividends generally taxed at 23.8 percent (20% plus 3.8% Tax on Net Investment Income).
To qualify as an IC-DISC, a corporation must also:
- Be incorporated in one of the 50 states or in the District of Columbia,
- File an election with and receive approval from the IRS to be treated as an IC-DISC for federal tax purposes,
- Maintain a bank account,
- Maintain a minimum capitalization of $2,500 of authorized and issued shares,
- Have only a single class of stock, and
- Meet an annual qualified export receipts test and a qualified export assets test. This last requirement means that at least 95 percent of an IC-DISC’s gross receipts and assets must be related to the export of property whose value is at least 50 percent attributable to United States domestic-produced content.
How Does an IC-DISC Work?
Since the “C” corporation qualifies as an IC-DISC, it is presumed to have participated in the export sales activity, and due to that participation, it is entitled to earn a commission. Your Company (the Related Exporter) is then allowed to pay tax-deductible commissions to the IC-DISC, which are equal to the greater of (i) 4 percent of your Company’s gross receipts from Qualified Exports, or (ii) 50 percent of your Company’s net income from Qualified Exports. Your Company’s taxable income is reduced by the amount of the commissions paid to the IC-DISC and such commissions are deductible against ordinary income.
The IC-DISC, as a tax-exempt entity, pays no federal tax on the commission income. When the IC-DISC distributes its income to its shareholders, their dividend income is taxed at the qualified dividend rate of 20 percent (plus 3.8% Tax on Net Investment Income). The qualified dividend rate is available only to individuals; thus, you’ll need to structure the ownership of the IC-DISC so that the IC-DISC dividends are considered to be received by individuals.
If your Company is a pass-through entity—such as a partnership, S corporation, or LLC—you can form an IC-DISC as a subsidiary. Dividends that the IC-DISC distributes to your Company will retain their character and be passed through to individual shareholders and qualify for the 20 percent rate.
If your Related Exporter company is a “C” corporation, however, you will need to have the corporation’s individual shareholders form the IC-DISC as a brother-sister corporation in order to obtain the lower tax rate on qualified dividends. If you set up the IC-DISC as a subsidiary instead, the dividends will be paid to the Related Exporter “C” corporation and taxed at regular corporate income tax rates – therefore, no tax savings.
An IC-DISC Calculation Example
EXAMPLE: A Related Exporter is an “S” corporation has $10 million in qualifying export sales and $1 million in net export income on those sales. If the Related Exporter has an IC-DISC subsidiary, it can pay commissions to the IC-DISC equal to the greater of 50 percent of its export net income or 4 percent of its export gross receipts. In this case, the maximum commission is 50 percent of net income, or $500,000.
The IC-DISC distributes the entire $500,000 of commission income as a qualified dividend to its sole shareholder, the Related Exporter “S” Corporation. The consequences are as follows:
- The Related Exporter “S” corporation incurs an ordinary tax deduction of $500,000 for the commission paid to the IC-DISC.
- The IC-DISC receives $500,000 of nontaxable commission income.
- The IC-DISC pays a qualified dividend to the Related Exporter “S” corporation of $500,000, which also flows through the Related Exporter “S” corporation to its individual shareholders.
- The Related Exporter “S” corporation shareholders pay 23.8 percent federal income tax on the IC-DISC qualified dividend income.
- The IC-DISC net tax savings is $83,500.