Are You Exporting Without an IC-DISC? If So, Why?

By Christopher L. Nuss | October 11, 2013

If you’re exporting goods without an Interest Charge Domestic International Sales Corporation, you’re likely paying more income tax than necessary. By implementing a rather simple, low-risk tax planning strategy, you could realize significant tax savings on foreign sales.  

For individuals, directly or indirectly through pass-through entities such as limited liability companies or S corporations, an IC-DISC may reduce the tax rate on export profits from the ordinary income tax rate to the dividend rate—a savings on tax rates of up to around 16 percent—each year, with such savings being currently “permanent” (at least until Congress changes the law). Similarly, closely held C corporations can also benefit from implementing an IC-DISC with what essentially becomes a tax-deductible dividend. IC-DISCs can also aid in wealth transfer or executive compensation arrangements for the exporter.

An IC-DISC is a corporation formed under state law that:
• Has a single class of stock. 
• Maintains minimum capitalization of $2,500. 
• Has qualified export receipts and qualified exports assets.
• Elects to be taxed as an IC-DISC.  

If all of these requirements are met, an IC-DISC is not subject to federal (and many states’) income tax on commission payments received from the exporter. Instead, the IC-DISC shareholders are typically taxed on the distribution of those payments as dividends.

To qualify as an IC-DISC, at least 95 percent of its receipts must be from selling or leasing “export property.” Property that is, one, manufactured, produced, grown, or extracted in the U.S. by a person other than an IC-DISC, two,  held primarily for sale in the ordinary course of business for use outside of the U.S., and, three, not more than 50 percent of its value is comprised of imported materials. This does not require that 95 percent of the exporter’s receipts be from exports. It simply requires that the IC-DISC be paid by the exporter based on export sales. Through agreements between the exporter and the IC-DISC, it can be ensured that the IC-DISC is paid based only on qualified export receipts. 

Note that there are certain types of property that do not meet the definition of export property, such as most intellectual property and products that deplete like oil, gas, and coal, which should not include typical ethanol manufacturing. 

Assuming the exporter is taxed as a pass-through entity that wholly owns the IC-DISC, the entity exports the goods and pays the IC-DISC a commission based on those export sales that is deductible for income tax purposes and not taxed to the IC-DISC. Then, the IC-DISC distributes back to the exporter that same amount, which passes through to the exporter’s shareholders and is taxed to them at the dividend rate, not the ordinary income tax rate it otherwise would have been without involving the IC-DISC.

The amount of the “commission” cannot exceed 50 percent of the export taxable income or 4 percent of export gross receipts. In determining export taxable income, certain direct and indirect expenses can be allocated and apportioned between export and nonexport activities to maximize tax savings under formulas that generally avoid the risk and uncertainty of IRS transfer pricing rules. Further, to determine export taxable income, there is flexibility in how sales are categorized—for example, by product line or even by transaction—to optimize the commission calculation, thus, optimizing tax savings.

Unlike other tax planning strategies, the IRS recognizes that IC-DISCs are not required to have economic substance, (e.g., have its own employees and operations) generally because of the desire to incentivize the export of U.S.-manufactured goods. Given that, however, care must be taken to ensure that all legal and technical requirements are met to qualify as an IC-DISC. An IC-DISC is not difficult to form with the help of experienced legal counsel, and is not overly burdensome, especially given the immediate tax savings that can be realized.

Note that this article is intended to be a general overview and not a comprehensive analysis of IC-DISC law. Moreover, it does not constitute legal advice. Competent legal counsel should be consulted to apply the relevant legal requirements of a specific situation.

Author:  Christopher L. Nuss|
Attorney, BrownWinick Law Firm