Are you an exporter? If any of the products that you manufacture, produce, grow, or extract in the U.S. are sold in other countries, you may qualify for a special tax incentive called the interest charge domestic international sales corporation or IC-DISC. The IC-DISC is an election created by the IRS to help American companies become more globally competitive by lowering their federal tax liability. By creating an IC-DISC, some or all of your business’ taxable income can be taxed at the qualified dividend rate. This rate tops out at 20% versus the ordinary income tax rate, which can be as high as 37%.
What are the requirements for setting up an IC-DISC?
The IC-DISC starts its life off as a corporation. By making this election, you are forming a separate legal entity that can be incorporated in any state in the U.S. To form an IC-DISC, you must have:
- A single class of common stock—this means that all shareholders are offered equal rights and responsibilities.
- Minimum capitalization of $2,500—this can be met by depositing $2,500 in the entity’s checking account.
- Separate books and records—the IC-DISC is a real corporation and must function separately from your original company.
- At least 95% “qualified” assets on its balance sheet—the vast majority of the IC-DISC’s assets have to be held in connection with exporting activities. These assets 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. First, you file the election, set up separate books and records, and capitalize the accounts. Remember that this is a legitimate corporation, so you need to create all the required documents, 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 your IC-DISC.
To elect the IC-DISC, use Form 4876-A. This form must list the date of incorporation and the date of election as the same date. This shows the IRS that this is a new corporation formed just to be an IC-DISC. 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 you cannot gain that tax reduction on money made before you set up the IC-DISC.
Step 2: The export company pays the commission in IC-DISC. This refers to the amount of income that you are reclassifying from ordinary income to qualified dividends. That reclassified money then becomes deductible as an expense to the exporting company, reducing your company’s taxable income.
There are two common methods of calculating the commission amount and one more complicated method:
- 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 your export (less common)
You will 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 that lower qualified dividend rate. 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, you would form the IC-DISC, pay the commission, and then the IC-DISC would invest in the PEFCO bonds. You have to move cash to take this route, and you can’t use offsetting entries (one of the benefits of an IC-DISC) because you 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. You will want to use Form 1120-IC-DISC and IRS Schedule P for each IC-DISC qualified transaction. If you have a producer’s loan, use Schedule Q to certify it.
If your company is already involved in foreign sales, the IC-DISC is a readily available benefit to help you become more profitable as an exporter. If you qualify for this election, be sure to follow every step, especially paying the dividend back to the exporting company—some companies only get as far as paying the commission and forget the step that actually results in the tax savings!
For expert assistance understanding the requirements for an IC-DISC and maximizing your company’s tax savings, reach out to a Certified Tax Planner today.
To learn more about IC-DISC, read part 1 of this article, “How Exporting Goods Can Lead to Tax Savings: Discovering the IC-DISC.”