If you are working with a company that sells goods made in the U.S. in foreign markets, you may want to introduce this lucrative 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?
The benefit of creating an IC-DISC is that some or all of the taxable income from export sales will be taxed at a lower rate—namely, the qualified dividend rate. The highest qualified dividend rate is 20%, whereas the ordinary income tax rate can be as high as 37%.
To benefit from this tax incentive, your client’s company must make an IC-DISC election with the IRS. If they meet the qualifications, the IC-DISC will then become its own entity, separate from the original business, so it 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.” Let’s look more closely at the three key components in this definition:
- A closely or privately held U.S. manufacturer or distributor. Essentially, 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 manufacture products qualify, but so do distributors. So if a company buys pistachio nuts from an orchard in California and distributes them overseas, they may be able to take advantage of the IC-DISC. Since the rules allow for companies that export goods both directly or indirectly, the orchard itself can also take advantage of an IC-DISC.
However, once an IC-DISC is created, this new entity cannot be the producer or manufacturer of the product. The exported product must be manufactured, produced, grown, or extracted within the U.S. by a person other than the IC-DISC. The IC-DISC does not need to have employees or participate in sales or services—it is simply a vehicle for tax savings. This functionality is completely above board. The IC-DISC is a legal provision that has been around for over 50 years.
- Products are manufactured, produced, grown, or extracted within the U.S. The abbreviation “MPG&E” appears everywhere in the regulations, so understanding what falls under each category is essential. Below are some key items in each bucket:
- 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 must also meet one of the following qualifications:
- 20% of conversion costs occur within the U.S.—meaning the direct labor and manufacturing needed to turn raw materials into the final product.
- Substantial transformation occurs in the U.S.—meaning 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.
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.
- Products are delivered outside the U.S. If a company’s product is sold internationally, they will likely qualify. 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 that is exported and then sold back to the U.S. when the project is completed. In that case, the export would not qualify 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, they can still qualify. The same is true for airplanes, fishing boats, passenger vessels, and similar products.
Summary
The IC-DISC election was created by the IRS to incentivize companies to continue manufacturing and operating within the U.S. while still reaping the benefits of foreign sales. If your client’s company distributes goods to countries outside the U.S., look into the requirements for the IC-DISC to see if they qualify for this tax incentive. By following a simple set of steps, the company could secure a lower qualified dividend rate for all or part of their taxable income.
To learn more about lesser-known strategies like the IC-DISC and provide maximum benefits to your business clients, become a Certified Tax Planner today.
To learn how to set up an IC-DISC, read part 2 of this article, “Tax Breaks for Businesses: Setting Up an IC-DISC.”
