An Interest Charge-Domestic International Sales Corporation (IC-DISC) is a strong tax-saving opportunity. With the extension of capital gains tax rates for qualified dividends included in the Tax Relief Act of 2010, permanent tax savings result from the current tax rate differential.
What is an IC–DISC?
An Interest Charge-Domestic International Sales Corporation is a powerful export incentive that can provide permanent federal tax savings to U.S. exporters. It’s available to exporters of products and certain services that are produced in the United States and sold for ultimate use outside of the United States.
To create an IC-DISC, a new entity is formed. This entity acts as a commission agent for all qualifying exports of the related supplier (your company).
When the new entity makes an election to be treated as an IC-DISC, it is not subject to federal tax on its earnings. As the related supplier, your company is allowed a deduction for the IC-DISC commission that is calculated on export profits. The IC-DISC makes dividend distributions of its earnings to shareholders. These distributions are treated as qualified dividend income.
Permanent tax savings result from the deduction of the commission at ordinary income rates (35 percent), and the qualified dividend income taxed at just 15 percent, for a savings of 20 percent on the calculated commission.
How an IC-DISC Impacts Your Business
Basically, an IC-DISC is an internal "paper corporation." It has no impact on the operations of your business, and is totally transparent to your customers.
To report its income and distributions, the IC-DISC files a federal tax return using Form 1120-IC-DISC. Your company can take an ordinary deduction, and the IC-DISC shareholders have corresponding qualified dividend income.
IC-DISC Technical Requirements
Several technical requirements must be in place before an IC-DISC can be formed. First, your company must produce qualified export property, which is defined as property manufactured, produced, grown or extracted in the United States (though not necessarily by the exporter – resellers can also claim benefits).
- Less than 50 percent of the fair market value of the final product can be related to foreign content
- Components can qualify
- Used equipment and scrap can qualify
- "Related and subsidiary services" can qualify
A destination test must also be met. The property must be for direct use, consumption or disposition outside of the United States. Products may be shipped to a freight-forwarder, and sales to a "middle-man" can also qualify. Products must leave the United States within one year of the original sale. If requested, documentation must be available to provide proof of export.
Reducing Taxes with an IC–DISC
At year end, your company identifies its qualified export sales, and the corresponding cost of sales. Your expenses are then allocated, and an export taxable income is calculated. Statutory pricing methods are applied to calculate the DISC commission as the greatest of:
- 4 percent of export gross receipts
- 50 percent of export taxable income
- Marginal costing is also available
IC–DISC commission is calculated on a transaction-by–transaction basis, with the application of the optimal pricing method to each. Although a more summarized computation is allowed, the transactional approach generally results in far greater tax savings.
How to Establish the Entity
Tax benefits of an IC–DISC will only be applicable to income transferred to the IC–DISC after the entity is created. The new IC–DISC entity is a C corporation requiring only $2,500 of capitalization. It can be owned directly by the related supplier S corporation (your company), LLC or by individual shareholders of a closely held C corporation or a trust. It can be formed in any of the 50 states.
Only a small percentage of United States exporters who could benefit from an IC–DISC are actually doing so. And some that have established an IC–DISC may not have fully captured available tax savings. Exporters should enlist the assistance of an experienced IC–DISC practitioner to ensure that you meet qualification requirements and achieve the highest potential tax savings.