If you are in the export business, you may have heard of an interest charge domestic international sales corporation, otherwise called an IC-DISC. If this is your first time hearing about it, there is a lot of information to cover. Let’s get started!
First and foremost, an IC-DISC is one way an export company can reduce their taxable income. Your company (aka the exporter) can pay the commission of the IC-DISC (owned by shareholders or partners). These commissions are then deductible by your company for federal tax reasons, and the IC-DISC is an exempt entity. Pretty cool right?
If your company has taken advantage of this kind of strategy in the past, it’s crucial to understand the nuances of the IC-DISC and how tax law can impact your business for the next tax season.
What Is An Interest Charge Domestic International Sales Corporation?
An IC-DISC is an export tax incentive that offers federal income tax savings to U.S. domestic businesses that export U.S. made goods. The tax incentive was created in 1971 by Congress to promote the increase of exports by allowing companies 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 gains rate of 20% — much lower than the rate for flow-through entities (39.6%) and C corporations (35%).
What Are The Requirements For An IC-DISC?
You might be wondering if setting up an IC-DISC is right for your business. There are many benefits to setting up this type of strategy, but your business must qualify and therefore follow the IC-DISC rules. The export sales must meet these stipulations, according to Eide Bailly:
- The export property must be manufactured in the US
- The export property must be sold for direct use outside the US
- 50% or less of the sales price must be attributed to imported materials
Generally, an IC-DISC is not taxed on its income. However, the shareholders of the IC-DISC are taxed when the income is distributed. According to the IRS, to qualify as an IC-DISC, a domestic corporation must meet the following terms:
- Have a minimum of 95% of its gross receipts (within the given tax year) qualify as exports
- Export assets must be at least 95% of the sum of the adjusted basis of all its assets
- Have only one class of stock, and any outstanding stock should come to at least $2,500 every day of the new tax year
- New corporations
- 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
- 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.
Several different types of corporations may qualify for IC-DISC status and the associated DISC 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:
Here are a few examples of companies that may be eligible for IC-DISC elections:
- If it exports 95% of its goods
- A “good” is a broad term that can refer to several different items – such as agricultural products, technology, or art
- It provides architectural or engineering services conducted in the U.S. for building a structure outside of the U.S.
- Example: Company A is based in Austin, Texas, and designs a bridge built in Brazil
- It manufactures a product that goes into another product that is exported outside of the U.S.
- Example: Company A manufactures rubber for shoes that are shipped to New Zealand
How To Set 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 what is on paper
- any activities unrelated to the export of U.S. goods
The DISC will maintain a contract with the first corporation (the “Supplier”) that produces or resells the 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, it’s not subject to federal income tax. Therefore, any profits from the DISC are distributed to its shareholders as a dividend. For this reason, it only incurs taxes at the rate applied to dividends, which are currently significantly less than the federal income tax level.
What Are The Potential Tax Savings Of A DISC?
One of the most intriguing aspects of this strategy is the calculation of commission paid expense to the IC-DISC by the company who owns it.
There are a few simplified methods used to calculate the commission:
- 4% of gross export receipts
- 50% of combined taxable income from export sales
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 net savings by the owners of $1.84 million.
When Is It Time To File A DISC?
Mark your calendars! A corporation must file 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. The IC-DISC tax returns are filed with the Covington Kentucky Service Center.
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 correctly, read the IRS instructions for Form 1120-IC-DISC.
What Should You Do Next?
Think your corporation may be eligible to file for DISC status? Discuss it with your accounting department, outsourced accounting team, or tax provider and get their feedback. Signature Analytics is also available to discuss the DISC status of your business, as well as any accounting support or financial analysis needs you may have.
Read More: Outsourced CFO Services
Signature Analytics does not provide tax services, but we can act as the accounting and finance department on our clients’ behalf. This allows us to regularly work with tax providers on identifying strategies for minimizing a corporation’s tax bill.
Contact us today to learn more or to schedule a free consultation.