If your company has taken advantage of IC-DISC in the past, it’s important that you understand how tax laws can impact your business for the upcoming tax season.
According to the IRS, in order to qualify as an IC-DISC, a corporation must meet the following:
- Have at least 95% of its gross receipts qualify as exports.
- Not a member of a controlled group where a member is a foreign sales corporation (FSC).
- Elect to be treated as an IC-DISC for the tax year.
- Export assets must be at least 95% of the sum of the adjusted basis of all its assets.
- Maintain separate records and books.
Companies may benefit from reviewing the IC-DISC benefit before filing taxes. Many business owners are not aware of the IC-DISC tax incentive and end up missing out. Although Signature Analytics does not focus on providing tax services, we can 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. Read on to learn more about IC-DISC and how it could benefit your corporation to file as one.
What is an IC-DISC?
An IC-DISC is an export tax incentive that offers Federal income tax savings to U.S. domestic businesses who export U.S. made goods. The tax incentive was created in 1971 by Congress to promote the increase of exports by allowing businesses to defer income and have interest charged on the deferred tax. Shareholders of a DISC receive reduced income tax rates on qualifying income from exports of U.S. made goods.
Under IC-DISC, income related to export sales can be taxed at a lower capital gain rate of 20% — much lower than the rate for flow-through entities (39.6%) and C corporations (35%).
Does Your Corporation Qualify to Elect IC-DISC Status?
Several different types of corporations may qualify for IC-DISC status and the associated tax benefits. Specifically, the law states that if a domestic company meets all the following criteria, it’s eligible to apply for Domestic International Sales Corporation status:
- Receives 95% or more of gross receipts from qualified exports.
- 50% of the total corporate asset value is related to the export of such goods.
- Has only one class of stock, and the outstanding stock has a value of at least $2,500.
Here are a few examples of companies that may be eligible for IC-DISC elections
- A company exporting 95% of its own goods.
- A “good” is a broad term that can refer to several different items – such as agricultural products, technology, or art.
- A company that provides architectural or engineering services which are conducted in the U.S. for the purposes of a building a structure outside of the U.S.
- Example: Company A is based in Austin, Texas and designs a bridge that is built in Brazil.
- A company manufacturing a product which goes into another product that is ultimately exported outside of the U.S.
- Example: Company A manufactures rubber for shoes that are shipped to New Zealand.
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 can be charged by the DISC in a given year is the greater of:
- 4% of the qualified gross receipts from exports, or
- 50% 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.
When to File
A corporation must file the Form 1120-IC-DISC by the 15th day of the 9th month after the tax year ends and according to the IRS, no extensions are allowed.
Up until a recent IRS audit, corporations could mail in their DISC paperwork, however the IRS found numerous recurring errors on the documentation. The IRS now audits IC-DISCs, making sure that companies provided the proper documentation for the IC-DISC. According to the IRS, to properly prepare the IC-DISC return, all schedules and forms must be returned in the following order:
- Schedule N (Form 1120).
- Form 4136.
- Schedule D (Form 1120).
- Form 8992.
- Form 8993.
- Additional schedules in alphabetical order.
- Additional forms in numerical order.
To read more on how to file your IC-DISC properly, read the IRS instructions for Form 1120-IC-DISC.
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.