If your business manufactures goods, develops software, generates power, or helps construct buildings in the United States, you may qualify for significant tax benefits. And if your company exports your goods overseas, or you can trace your products into foreign commerce, you may qualify for powerful export tax incentives.
But the process is not that simple, according to Mark Gasbarra, a National Managing Director with Forte.
“Some of these deductions and incentives are incredibly complex. For example, we find that less than 10 percent of eligible companies are taking advantage of the IC-DISC incentive program.”
Also, major tax reform and budget proposals could further impact these incentives, depending on who is seated in the White House.
Domestic Production Activities Deduction (DPAD)
Known to tax professionals as Section 199, this valuable deduction is an incentive program by the U.S. government to encourage U.S. businesses to keep products made domestically.
DPAD allows for a deduction equal to 9 percent of the greater of qualified production activity income (QPAI) or taxable income. Considering that our highest U.S. corporate tax rate is 35 percent, this results in a permanent tax savings of 3.15 percent on QPAI.
Maximize qualified production activity income
To get a permanent tax savings, increase QPAI up to the overall taxable income limitation. To increase QPAI, identify all possible sources of domestic production gross receipts (DPGR) and then minimize expenses that are allocated and apportioned to DPGR under IRS Reg. 1.861-8.
1.861-8 allocation and apportionment regulations
Generally U.S. taxpayers must follow the 1.861-8 method to allocate and apportion the deduction to specific “statutory groupings” of gross income. These groupings will determine the foreign tax credit limitation, QPAI, and other operative sections of the Internal Revenue Code, including the export tax incentives discussed later in this article.
Although there is specific guidance on how to take the deductions, taxpayers are given a significant degree of latitude in how they develop their allocation and apportionment methodologies, as long as the methods used are reasonable and are consistently applied to all statutory groupings.
However that latitude means taxpayers face a difficult decision between foreign source income and DPAD.
“If a taxpayer has multiple statutory groupings, there is a need to consider the overall effect of the selected methods,” says Gasbarra. “For example, the apportionment methods most advantageous for increasing foreign source income will likely work against the DPAD calculation.”
Export incentives and IC-DISC
The Interest Charge Domestic International Sales Corporation (IC-DISC) is effectively the last remaining specific export incentive. It was designed primarily as a way to defer U.S. taxation on $10 million of exported gross profit. Today, an IC-DISC can provide permanent tax savings by effectively converting ordinary income (maximum tax rate of 35 percent) to qualified dividend income (maximum tax rate of 15 percent).
“To take advantage of this extremely powerful incentive, you must first elect IC-DISC treatment for a domestic corporation established in any of the 50 states,” says Gasbarra. “No export transaction will qualify for this preferred treatment until you establish the IC-DISC.”
Extraterritorial Income Exclusion
Additional tax benefits can be found under the phased-out extraterritorial income exclusion (EIE). Although EIE is officially repealed, substantial untapped EIE tax savings related to pre-2007 tax years may be available. Those benefits may be realized by increasing the exclusions for any open tax years and/or by adjusting net operating loss carry-forwards for any pre-2007 tax years.
Foreign title passage
One somewhat hidden export tax incentive is the foreign title passage sourcing rules of Sections 862 and 863(b). Sales of products purchased in the U.S. (with title passing outside our borders) are treated as 100 percent foreign sourced income, while sales of products manufactured in the U.S. (with title also passing outside the country) are generally treated as 50 percent foreign sourced income.
“Conversion of U.S. source income to foreign source income on export transactions can result in a substantial boost in a taxpayer’s foreign tax credit limitation,” says Gasbarra. “The result is permanent cash tax savings and effective tax rate benefits.”
How we can help
No one can predict the future, but we can maximize the benefits that are available today. Your Forte tax advisor can review your existing structure to make sure you are taking advantage of the full range of tax incentives that Congress has specifically enacted to support U.S. manufacturing and exporting activities.