The interest charge domestic international sales corporation (IC-DISC) is available to manufacturers, producers, resellers, and exporters of goods that are produced in the United States with an ultimate destination outside the United States. The IC-DISCs defers the recognition of income related to foreign sales and may also reduce the income tax liability of a corporation’s shareholders by converting ordinary income into qualified dividend income.
An IC-DISC reduces its shareholders’ income tax liability by converting ordinary income from sales to foreign unrelated parties into qualified dividend income.
Step 1: Form a corporate entity (the new entity i.e. the IC-DISC is exempt from federal income tax under Sec. 991) separate from the related producer, manufacturer, reseller, or exporter. Also, set up the IC-DISC bank account.
Step 2: Qualify the company with the IRS.
Step 3: When the IC-DISC structure is in place, the producer pays and deducts the IC-DISC a tax-deductible commission that is calculated based on the related supplier’s foreign sales or foreign taxable income for the year.
Step 4: The IC-DISC then distributes that commission to its shareholders in the form of qualified dividends under Sec. 995(b)(1). These calculations and payments are generally made once the tax year is complete and the related supplier’s taxable income can be accurately determined or estimated.
Entities that sell “export property” and are profitable. Export property as property:
- That is manufactured, produced, grown, or extracted in the United States;
- That is then held for sale, lease, or rental for direct use, consumption, or disposition outside the United States; and
- The fair market value of which is not more than 50% attributable to articles imported into the United States.
The definition focuses on the source and ultimate use of the products and not their producer.
What’s the Commission?
Assuming the producer has taxable income, there are two primary methods to calculate the commission under Section 994(s):
(1) 4% of the qualified export receipts, or
(2) 50% of the combined taxable income of the related supplier and IC-DISC from the sale of qualified export property (generally, this would be 50% of foreign taxable income).
The higher the commission, the greater the benefit and the related supplier may select the method of commission calculation that is most beneficial to it each year.
How to pay the Commision?
The Regs. Sec. 1.994-1(e)(3), allow that the commission, or a reasonable estimate of the commission, can be paid to the IC-DISC within 60 days after the close of the tax year. The cash does have to move in that time frame to take advantage of the benefits and generally would have to meet or exceed the final commission amount. If the related supplier does not make the payment within the 60-days, the IC-DISC may lose the tax benefits associated with being an IC-DISC.
Assuming that the commission is calculated as described above and the commissions and dividends are paid out every year, there is no statutory limit on how much income can be pushed through the IC-DISC annually, aside from the taxable income limitation and the limitations inherent in the commission calculations.
Structuring the IC-DISC?
IC-DISCs that are owned directly by the related supplier and structured as passthrough entities (partnerships and S corporations) are able to pass through the qualified dividend income directly to their individual partners or shareholders. Parent-subsidiary or brother-sister entity structures both work well when the related supplier is a passthrough entity. Related suppliers structured as passthrough entities, coupled with the parent-subsidiary ownership structure of the IC-DISC, work well when cash flow is a concern, because the passthrough entity pays the dividend to the IC-DISC and then receives the cash dividend back from the IC-DISC. The passthrough entity is then able to pass the character of the qualified dividend income it received from the IC-DISC up to the shareholders or partners without having to actually distribute the cash out of the company to realize the tax savings.
Let’s do this!
IC-DISCs are incorporated as C corporations and set up at the state level. An election is made to treat the entity as an IC-DISC, similar to how an S election is made. Under Regs. Sec. 1.992-2(a), the election to be treated as an IC-DISC is made on Form 4876-A, Election to Be Treated as an Interest Charge DISC, and must be filed within 90 days of the beginning of the tax year in which the election will take effect.
The marginal cost of setting up and maintaining the IC-DISC are 1) the cost of set-up and 2) ongoing cost of a) maintaining qualification with the IC-DISC state of incorporation (typically hundreds of dollars) and b) the professional fee cost of filing tax returns for the IC-DISC.
Requirements to Maintain IC-DISC Status
The IC-DISC must maintain the following requirements annually:
- 95% or more of the gross receipts the IC-DISC receives are qualified export receipts;
- The adjusted basis of the qualified export assets meets or exceeds 95% of the total adjusted basis of all assets held by the IC-DISC;
- The IC-DISC maintains only one class of stock;
- The par value of the stock is at least $2,500 for each day of the tax year;
- The corporation maintains separate books and records; and
- The election to be an IC-DISC described above is in effect for the tax year.
Qualified export assets under Sec. 993(b) include:
- Export property;
- Assets used primarily in connection with the sale, lease, or other specified activities relating to qualified export property, and in connection with performing certain services;
- Sufficient cash required to meet the working capital requirements; and
- Amounts on deposit in the United States used to acquire other qualified export assets, subject to the limitations of Regs. Sec. 1.993-2(j).
If an IC-DISC does not meet and maintain these requirements each year, it could lose IC-DISC status and the associated tax savings.