How many of the companies you work with are exporters? Your clients may not readily identify themselves this way, but if any of the products they manufacture, produce, grow, or extract in the U.S. are sold in other countries, they may qualify for a special tax incentive called the interest charge domestic international sales corporation or IC-DISC. Created by the IRS to help American exporters become more globally competitive, the IC-DISC election can substantially lower a company’s tax liability. An IC-DISC reclassifies some or all of a business’ taxable income so that it is taxed at the qualified dividend rate—a maximum of 20% versus the maximum ordinary income tax rate of 37%.
What are the requirements for setting up an IC-DISC?
The IC-DISC is a separate legal entity that is incorporated in any state in the U.S.—so it starts its life off as a corporation. To form an IC-DISC, you must have:
• A single class of common stock
• Minimum capitalization of $2,500
• Separate books and records
• At least 95% “qualified” assets on its balance sheet—these assets must be held in connection with exporting activities and can include export property, trade receivables, temporary investment, producer’s loans, and a number of other business assets.
What are the steps to setting up an IC-DISC?
Step 1: The export company creates the IC-DISC. The company starts by filing the election, setting up separate books and records, and capitalizing the accounts, which can mean simply making a deposit in the IC-DISC’s checking account. Since this is a legitimate corporation, it needs all the documents required of any business entity, such as bylaws, subscription agreements, and stock certificates. These can all be electronic—they just need to be readily available if the IRS chooses to examine the IC-DISC.
The company can elect the IC-DISC using Form 4876-A. The date of incorporation listed must be the same as the date of election. This form must be filed with the IRS within 90 calendar days of incorporation. The tax benefits start as of the date of incorporation, so the company cannot gain a tax reduction on money made before they set up the IC-DISC.
Step 2: The export company pays the commission in IC-DISC. This refers to the amount of income being reclassified from ordinary income to qualified dividends. The commission is deductible as an expense to the exporting company.
There are three possible methods for calculating the commission amount:
- Take 4% of gross receipts from export sales—limited to taxable or Combined Taxable Income (CTI)
- Take 50% of CTI export sales
- Use marginal costing, which calculates the amount based on the worldwide margin for the type of export (less common)
Each company will have to decide which method to use based on which yields the highest number—and therefore the biggest deduction.
Step 3: The IC-DISC pays a qualified dividend to the exporting company as the owner of the IC-DISC. This dividend is taxable at a qualified dividend rate of 20% or 23.8% (if it is subject to the net investment income tax). Remember that S Corporations, LLCs, and partnerships can own the IC-DISC, but C Corporations require a brother-sister ownership structure.
An alternate step here is for the IC-DISC to invest the commission into PEFCO bonds. In this case, the company would form the IC-DISC, pay the commission, and then the IC-DISC would invest in the PEFCO bonds. This route requires the company to move cash and prevents them from using offsetting entries because they have to buy those bonds. When the IC-DISC cashes those bonds out and distributes the income, then the money is taxable as a dividend.
Step 4: The IC-DISC files an annual tax return with the IRS. Lastly, the company will want to use Form 1120-IC-DISC and IRS Schedule P for each IC-DISC qualified transaction. If they have a producer’s loan, they will use Schedule Q to certify it. The taxpayer benefiting from deferral of income must also file Form 8404.
Summary
The IC-DISC is a readily available benefit for most companies involved in foreign sales. The U.S. government has a vested interest in helping American exporters become more profitable, and you can aid these efforts by checking if your clients qualify for this election.
To become more familiar with the requirements for an IC-DISC and how to leverage this election toward tax savings, become a Certified Tax Planner today.
To learn more about the benefits of an IC-DISC, read part 1 of this article, “Tax Breaks for Businesses: Discovering the Benefits of the IC-DISC.”
