updated September 1, 2023 · 3min read
Many exporters miss out on a lucrative tax incentive: an Interest Charge Domestic International Sales Corporation (IC-DISC). This tax strategy offers federal income tax savings for businesses that make or distribute U.S. products for export.
Could it benefit your business? Read on to learn more.
An IC-DISC is a separate corporation that earns a “commission" from an operating company's export sales. Paying this commission allows U.S. exporters to reduce their tax liability by transferring income from the exporter to the IC-DISC through an export sales commission.
The commission is based on the greater of:
The exporter receives a deduction for the commission paid, reducing their taxable income. The IC-DISC pays no tax because it is tax-exempt and distributes all profits to shareholders as qualified dividends. The owners of the IC-DISC pay tax on those dividends at more favorable long-term capital gains tax rates. Depending on the individual owner's personal tax situation, their qualified dividends may be taxed at 0%, 15%, or 20%, plus a potential 3.8% net investment income tax (NIIT).
To create an IC-DISC, you first need to form a corporation and get IRS approval to be treated as an IC-DISC. To qualify, the IC-DISC must:
However, the IC-DISC does not have to have a separate office, employees, or assets.
Once you make an IC-DISC election, it remains in effect for future tax years until you revoke the election.
There are costs associated with creating and administering an IC-DISC, including legal fees, filing fees, and the cost of filing a separate corporate tax return. However, the benefits can quickly outweigh the costs in the right situation.
To illustrate, say a home décor company has a net income of $1 million from its international exports. It pays a commission of $500,000 (50% of export net income) to an IC-DISC.
As a result of this commission payment, the exporter's taxable income is reduced by $500,000. Since the company is an S corporation, its sole shareholder reports this income on their individual tax return. Assuming the shareholder is in the top tax bracket and taxed at 29.6% (the top rate of 37% x 80% for the qualified business income deduction), the commission results in a federal tax savings of $148,000 for the shareholder.
The $500,000 paid to the IC-DISC is paid out to the shareholder as a qualified dividend, taxed at 23.8% (the top 20% long-term capital gains rate plus the 3.8% NIIT). This results in a tax of $119,000. As a result, the shareholder receives a tax savings of $29,000 ($148,000 - $119,000).
When used effectively, an IC-DISC can create significant tax savings and free up operating cash flow for exporters. However, navigating the complexities involved, including filing for the IC-DISC election and calculating your qualified export receipts, can be complex. For that reason, it's a good idea to discuss your potential tax savings with a qualified tax adviser.
by Janet Berry-Johnson
A freelance writer with a background in accounting and income tax planning and preparation for individuals and small ...
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