If your company sells goods made in the U.S. to foreign countries, you will want to familiarize yourself with this tax incentive: the interest charge domestic international sales corporation, more commonly known as the “IC-DISC.” Geared specifically toward American exporters, this incentive helps companies become more globally competitive by lowering their U.S. taxes. Below we will cover what this incentive offers and who qualifies.
What is an IC-DISC?
What is the point of creating an IC-DISC? This IRS election can allow some or all of the taxable income from your export sales to be taxed at a lower rate. The IC-DISC enables you to reclassify income so that it is taxed at the qualified dividend rate, which will be 20% at the most. Comparatively, the ordinary income tax rate can be as high as 37%.
If you meet the qualifications, you can make an IC-DISC election with the IRS, which creates the IC-DISC as a brand new entity. This means that the IC-DISC must maintain its own books, have its own bank accounts, file its own tax returns, and pay its own organizational fees.
Who Qualifies for an IC-DISC?
According to the U.S. Treasury Regulations, this incentive is available to “Any closely or privately held U.S. manufacturer or distributor whose products were delivered outside of the United States that are manufactured, produced, grown, or extracted within the U.S.” To break that down into more digestible pieces, let’s look at this definition’s three main components:
- A closely or privately held U.S. manufacturer or distributor
- Products are manufactured, produced, grown, or extracted within the U.S.
- Products are delivered outside the U.S.
A closely or privately held U.S. manufacturer or distributor. This means this benefit does not apply to publicly traded companies. However, a C corporation, S corporation, LLC, or sole proprietorship that is owned by an individual or small group of shareholders can qualify.
Companies that make products for sale (manufacturers) qualify, but so do distributors. So if your company buys pistachio nuts from an orchard in California and distributes them overseas, you may be able to take advantage of the IC-DISC. In fact, companies that export goods directly or indirectly both qualify, so the orchard can likely also create an IC-DISC in this scenario.
Once an IC-DISC is created, this new entity cannot be the producer or manufacturer of the product. That role must stay with the original company. The IC-DISC is simply a vehicle for tax savings—it does not need to have employees or participate in sales or services. This is not a tax shelter or a strategy invented by tax advisers. Rather, this is an election provided by the IRS that has been around for over 50 years.
Products are manufactured, produced, grown, or extracted within the U.S. Below are some key items in each “MPG&E” bucket to give you a sense of how the terms are being used:
- Manufactured: Equipment, heavy machinery, high tech
- Produced: Food, films, software, architectural and engineering designs
- Grown: Agriculture, horticulture, processed timber
- Extracted: Seafood, scrap metal
- Note that primary products from oil, gas, coal, and uranium do not qualify.
The producer of the product (the original company) must also meet one of the following qualifications:
- 20% of conversion costs occur within the U.S.—conversion cost refers to the direct labor and manufacturing needed to turn raw materials into the final product.
- Substantial transformation occurs in the U.S.—this means that the goods underwent a significant change in their form, appearance, nature or character.
- Manufacturing occurs in the U.S. as defined by trade or industry standards—so for instance, in the timber industry, if you fell logs, that is defined as manufacturing in the U.S. and would pass the test.
Additionally, the regulations say that no more than 50% of the fair market value of the product can be linked to components that were imported to the U.S. For this to be a “U.S. made” product, at least 50% of its contents must be domestic.
Products are delivered outside the U.S. If your product is sold internationally, it likely qualifies. Some companies make the mistake of thinking the product must travel “overseas,” but Canada and Mexico certainly count. The only nations that will not qualify are where the U.S. has trade embargos, such as Iran and North Korea. U.S. territories also do not qualify, including Puerto Rico, Guam, and the U.S. Virgin Islands.
The product also cannot return to the U.S for three years. This can occur sometimes with heavy equipment and machinery. For example, if a company exports bulldozers to South America, once the construction project is completed, it is possible that the same bulldozers could be sold back to the U.S. If this happens, these exports will not qualify you for the IC-DISC. An exception is in the realm of transportation. If a supplier rebuilds rail cars that travel between the northern U.S. and Canada, as long as those rail cars are outside of the U.S. at least 50% of the time, you can still qualify. The same is true for airplanes, fishing boats, passenger vessels, and similar products.
Summary
The IC-DISC election was created to help U.S. exporters become more competitive in the global market. If your company distributes goods to countries outside the U.S., look into the requirements for the IC-DISC to see if this tax incentive could work for you. If you meet the minimum as a U.S.-based manufacturer or distributor, you could secure that lower qualified dividend rate for your company’s taxable income.
To discuss whether your business qualifies and how to take the next steps toward setting up an IC-DISC, reach out to a Certified Tax Planner today.
To learn how to set up a IC-DISC, read part 2 of this article, “How Exporting Goods Can Lead to Tax Savings: Setting Up an IC-DISC.”
