IC-DISC example

Interest Charge-Domestic International Sales Corporation (IC-DISC)

IC-DISC Overview:

We have helped many of our clients establish and operate an IC-DISC as a means to minimizing their overall tax obligations. If you have significant foreign sales, you can benefit from the establishment of this specialized entity which can provide a permanent 20 percent tax savings for qualifying U.S. exporters. It also has a number of sophisticated features that can be tailored to help businesses meet objectives and goals.

IC-DISC advantages and benefits:

Permanent tax savings on global sales 
Permanent tax savings begins with the exporting company deducting the commission it pays to the IC-DISC from its ordinary income, which is taxed at 35 percent. Tax law sets the commission rate, which is based on export sales revenue, as the greater of either 50 percent of net income or 4 percent of gross income. Because the IC-DISC is tax exempt, tax is paid only on distributions to shareholders. Individual and pass-through company shareholders pay income tax on dividends at the capital gains rate of 15 percent.

EXAMPLE: The following example illustrates how a 20 percent tax rate arbitrage creates a permanent tax benefit of $160,000 on a commission of $800,000.

Increased liquidity for shareholders or the business 
Shareholders who need to rebalance their investment risk profiles can, in most cases, use the IC-DISC to gain additional liquidity. By extracting cash in this tax-advantaged manner, they can deploy resources pursuant to their investment risk profiles. IC-DISC liquidity also provides a tool for combating lending and debt restrictions that inhibit diversification and risk management. Rather than being reined in by restrictions, such as salary and dividend limitations and debt covenants, shareholders have flexibility to take actions that serve the best interests of the business.

Ability to leverage cost of capital 
An IC-DISC is more than a tax-savings vehicle. It can also be used as a deferral tool to leverage a company’s cost of capital. IC-DISC earnings need not be distributed to shareholders; the earnings can instead be used to perpetuate and grow the deductible dividend tax-rate savings. Tax-rate savings is perpetuated by lending accumulated IC-DISC earnings back to the exporting company in return for a note and interest. The exporting company can deduct the interest expense, and interest income is considered a dividend to the IC-DISC shareholders. Reinvesting IC-DISC earnings back into the exporting business results in additional tax-rate savings and diminishes the group’s cost of capital.

EXAMPLE: In the following example, reinvestment of IC-DISC earnings in the form of a loan back to the exporting company decreases the cost of capital to the group.

Make dividends paid by a C corporation tax-deductible 
C corporations, especially closely-held C corporations, can obtain a permanent tax savings for payments that would otherwise be made as dividends.   Provided that the C corporation has sufficient profits from its exporting activities, a “sister” IC-DISC can earn a commission equal to the amount of payments otherwise earmarked as dividends.  An otherwise non-deductible dividend payment has been converted to a tax-deductible commission expense, while receipt of the dividend by the shareholders is taxes the same whether received from a C corporation or an IC-DISC.

Means to facilitate succession planning 
An IC-DISC offers a number of capabilities for executing a succession plan. Among these, ownership in the IC-DISC can be used as a means of generating cash, which can be distributed to shareholders in a tax-advantaged manner. IC-DISC shareholders participating in a buyout of current or previous shareholders can leverage these tax-advantaged IC-DISC earnings to pursue the buyout plan.

Interact with Domestic Production Activities Deduction (DPAD) 
There is no prohibition against utilizing an IC-DISC and also claiming DPAD on qualifying production activities.  With respect to a product of service that otherwise meets all the respective applicable requirements, export sales qualify for export-related benefits based on where the product is used, consumed or disposed of, whereas any sale – export of domestic –qualifies for domestic production-related benefits based on where the production occurs.

The IC-DISC structure

The IC-DISC is a “paper” entity utilized as a tax-savings vehicle. It does not require corporate substance or form, office space, employees or tangible assets. It simply serves as a conduit for export tax savings. An important feature of the IC-DISC is that shareholders can be corporations, individuals or a combination of these.

How an IC-DISC works: 

• Owner-managed exporting company creates a tax-exempt IC-DISC
• Exporting company pays IC-DISC a commission 
• Exporting company deducts commission from ordinary income taxed at 35 percent 
• IC-DISC pays no tax on the commission 
• Shareholders pay income tax on dividends at the capital gains rate of 15 percent 
• Result is 20 percent tax savings on commission

Does your company Qualify?

If you are unsure about whether or not an IC-DISC will work for you, ask yourself the following questions:

Do you have any transactions outside of the United States? Do you use overseas distribution? Does your product cross any borders?

If you answered yes to any of these questions, then an IC-DISC could be a valuable tax-savings vehicle for your business. Please contact us to see how we can assist in the implementation of this tax-savings tool.