Although Signature Analytics does not focus on providing tax services, we do act at the accounting department on our clients’ behalf and therefore regularly work with tax providers on identifying strategies for minimizing a corporation’s tax bill.
One such strategy that many business owners may not be aware of is a provision in the tax law that dates back to 1971 to encourage exports of U.S. made goods called a Domestic International Sales Corporation (DISC). Shareholders of a DISC receive reduced income tax rates on qualifying income from exports of U.S. made goods.
Does Your Corporation Qualify to Elect DISC Status?
A number of different types of corporations may qualify for DISC status and the associated tax benefits. Specifically, the law states that if a domestic company meets all of the following criteria, it is eligible to apply to have a status as a Domestic International Sales Corporation:
- Receives 95 percent or more of gross receipts from qualified exports,
- 50 percent of the total corporate asset value is related to the export of such goods, and
- Has only one class of stock with the value of the par, or stated value of its outstanding stock, of at least $2,500.
Here are a few examples of eligible companies:
- A company exporting 95 percent of its own product.
- A company that provides architectural or engineering services which are conducted in the U.S for purposes of a building or other structure outside of the U.S.
- A company manufacturing a product which goes into another product that is ultimately exported outside of the U.S.
Setting up a Domestic International Sales Corporation
Once approved, a separate corporation is formed with the DISC status. This corporation will not have any activities other than on paper, or activities not related to the export of U.S. goods.
The DISC will maintain a contract with the initial corporation (the “Supplier”) that produces or resells U.S. made goods for export for services in exchange for a fee. The fee is deductible by the Supplier, which reduces its federal income tax. The fee will result in a net profit recognized by the DISC; however, because of its status, is not subject to federal income tax. Therefore the profit of the DISC may be distributed to its shareholders as a dividend and thus only incur taxes at the rate applied to dividends which is currently significantly less than the federal income tax level.
The maximum fee that is allowed to be charged by the DISC in a given year is the greater of:
- 4 percent of the qualified gross receipts from exports, or
- 50 percent of the Supplier’s net income from qualified exports.
Understanding the Potential Tax Savings of a DISC
To better explain the tax savings these entities may be eligible for, here’s an example:
A corporation has $40 million in gross export receipts and $15 million in net export income on such sales. If the owners have established a DISC entity, the greater of 4% of gross receipts ($1.6 million) or 50% of net export income ($7.5 million) may be paid as commissions to the DISC. This $7.5 million of commissions will reduce taxable income of the corporation and may be able to be distributed to the shareholders of the DISC as dividends.
Assuming a federal income tax rate of 39.6% the corporation will reduce its tax bill by $2.97 million. If the individual dividend tax rate were 15%, then the individual owners of the DISC who receive the dividend of $7.5 million will be required to pay taxes of $1.13 million. This results in a net savings by the owners of $1.84 million.
What Should You Do Next?
If you think your corporation may be eligible to file for DISC status, we suggest you discuss it with your accounting department (or outsourced accounting team) and tax provider. Signature Analytics is also available to discuss the DISC status of your business, as well as any additional ongoing accounting support or financial analysis needs you may have. Contact us today to learn more or to schedule a free consultation.
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