July 10, 2015

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IC-DISC Overview

UB Voices by CBIZ MHM

By Clair A Rood, Jr., Senior Managing Director | CBIZ MHM, LLC Salt Lake City

July 10, 2015


Companies whose products are ultimately used outside the U.S. can benefit from an often-overlooked Government incentive.

An increasing number of closely held companies are using the IC-DISC (Interest Charge Domestic International Sales Corporation) provisions of the Internal Revenue Code intended to help U.S. companies compete internationally. The incentive essentially reduces the top federal tax rates on income from certain qualified goods and services from either 43.4% or 39.6%, to 23.8% (assuming the NIIT (Net Investment Income Tax) of 3.8% is applicable). Incredibly, many eligible companies are still not utilizing the benefits, or are not realizing the full potential of this incentive. Additional benefits may be dramatically more significant depending on a company’s fact pattern and the level of detail in their IC-DISC calculations.

Background

Other tax incentives created by Congress to encourage domestic companies to export products and services have been repealed due to pressure from America’s trade partners (the EU and the WTO in recent years). The IC-DISC regime is the last remaining significant federal export tax incentive. The recent establishment of the qualified dividend rate at 20% effectively extended the IC-DISC’s benefits.

What Exactly is an IC-DISC, and How Does it Work?

The IC-DISC is a domestic corporation authorized by the Internal Revenue Code to encourage exports which has no disruption on business operations. The entity files a tax return - the 1120-IC DISC. Closely held companies (“S” and “C” corporations as well as LLCs) utilize the IC-DISC by paying a commission to their IC-DISC typically equal to half of their income from exported products. The DISC then commonly distributes the earnings back to shareholders. The IC-DISC itself is generally exempt from federal tax.  If however earnings are not distributed from the DISC then the shareholders are subject to an interest charge on this deferred dividend income. Distributions from the IC- DISC to its shareholders are taxed at a maximum rate of only 23.8% (including the 3.8% NIIT) rather than a maximum ordinary income rate of 39.6% or 43.4% (depending on whether the  3.8% NIIT is applicable).

How Can Companies Possibly Overlook or Not Fully Utilize an IC- DISC?

Despite the IC-DISC being a federal government incentive which the Department of Commerce urges business owners to use, common misconceptions abound. Some are the beliefs that the IC-DISC must actually export the goods, have employees, invoice customers, or perform other significant business activities. Implementation of a DISC is typically seamless, and only requires a few hours of work a year. Other common misinterpretations are that a company must be a manufacturer of goods, must export items, and must have foreign customers to benefit. While goods must have some level of U.S manufacturing or production, they need not be sold to a foreign customer. Perhaps the single largest missed opportunity involves sellers and producers of items that are sold within the U.S. but ultimately used or consumed outside the U.S.

Consider software produced in the U.S. by a Utah company and licensed to a multinational corporation based in New Jersey.  The Utah software company probably considers this license revenue to be ineligible for an export incentive. However, if the software is ultimately used by the N.J. multinational at their foreign subsidiary locations, all or a portion of license income may be a qualified export.  In addition, if the N.J. multinational were to embed the software into hardware and then sell this hardware to 3rd parties for use outside the U.S., all or a portion of the software revenue may be a qualified export. Other overlooked industries include agriculture, distributors, food processors, architectural & engineering services, and equipment lessors.

What if I Already Have an IC-DISC?

Most companies utilizing the IC-DISC enjoy the reduced tax arbitrage discussed above for either 4% of their qualified export gross sales (limited to the taxable income from those sales), or 50% of the taxable income from qualified export sales. Many believe that these are the maximum amounts used to determine the IC-DISC commission (which is subject to a top rate of 20%, rather than a top rate of 39.6%). In reality, these amounts should be considered the minimum commission amounts that result from the two simplest, basic methods. Truly maximizing the intended and allowable benefits from the IC-DISC does require a more in depth calculation, but may not take much more time. Each individual transaction can actually utilize a choice of many other attractive methods explicitly defined and encouraged in the regulations. For instance, even transactions that yield a loss can generate commission. Transactions for products with less than average profitability compared to their product group or product line may yield additional benefit. Often times an analysis utilizing the most beneficial of these methods for different transactions (yes, each transaction can use the best of a host of methods) can be performed using a company’s existing data from their sales and cost systems. Results can be dramatically higher than using the basic methods and applying to an aggregate amount.

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