IC-DISC SAVINGS FOR EXPORTERS

An overlooked tax break that could be your big break

Reduce Current & Future

Interest Charge Domestic International Sales (IC-DISC)

1 What Is An IC-DISC?

 An IC-DISC is a tax-exempt, domestic “paper” corporation set up to receive commissions on your ’s sales. It must have its own bank account, keep separate accounting records and file U.S. tax returns. But it need not have an office, employees or tangible assets, nor is it required to perform any services.

 An IC-DISC reduces your tax liability by converting a portion of your export income, which is taxable at ordinary income rates as high as 40.5%, into qualified dividends generally taxed at 23.8%.

2 IC-DISC History

 Started 1971: Revenue Act of 1971 establishes Domestic International Sales Corporation (DISC)  Changed in 1984: Interest Charge-DISC in response to European Economic Community  The Jobs and Growth Tax Relief Reconciliation Act of 2003: Qualified dividend reduced to 15% creates tax break  American Taxpayer Relief Act of 2012: Qualified dividend rate extended indefinitely at 15% - 23.8% depending on income bracket while raising top line tax rate to 39.6%  Applies to all types of taxpayers (Sole proprietors, , LLCs, S and C corporations)  IRC Code Sections: § 992, 993, 994, 995, 996

3 IC-DISC Basics

 An IC-DISC is a “paper corporation”, the related operating company continues with as usual  Tax benefits commence once an IC-DISC is established  Tax benefits are calculated annually  Available to all exporters whether a manufacturer, producer, grower, software developer or distributor  Qualified export property must have at least 50% U.S. content  Must be a U.S. taxpayer to benefit from an IC-DISC. It does not matter what type of company the operating company is. It can be a:

 LLC   C corporation

4 IC-DISC Basics

How do you qualify to save taxes through an IC-DISC?

1. Ultimate beneficiary or shareholder should be a U.S. Taxpayer.

2. Operating Company must be profitable.

3. Operating Company must export items of 50% or more U.S. content to locations outside of the U.S. whether directly or indirectly, or provide engineering or architecture services on construction projects outside of the U.S.

5 IC-DISC Basics

IC-DISC Taxes and its Shareholders  An IC-DISC is not subject to (IRC 991)  Money paid out of an IC-DISC is treated as a Qualified Dividend at a rate from 15% - 23.8%  If the exporting entity is a flow-through entity, tax savings are typically up to 17%  If the exporting entity is a C corporation, it can still benefit from the differential in rates and income is shielded from  Income can be deferred within the IC-DISC

6 Qualified Export Sales

Qualified Export Sales • Sale, exchange or other disposition of export property • Lease or rental of export property used outside of U.S. • Related and subsidiary services (engineering and architectural services; managerial services for furtherance of ) • Sales made to U.S. distributors • 50% or more of the content must be U.S. derived • Do not need to be the ultimate producer or ultimate exporter

7 Qualified Export Sales

Proof of Export • Copy of sales invoice • Copy of export bill of lading • Certificate of carrier showing delivery outside the U.S. • Certificate of lading by officer of foreign country • If no custom’s officer, written statement of recipient • Shipper’s export declaration filed with Bureau of Customs • Other proof: invoices, receipts, payment, etc.

8 IC-DISC Commission

The tax savings are based upon a commission agreement between the operating company and the IC-DISC

The Operating Company pays the IC-DISC this commission or ‘Export Management Fee’ based on the following:

 50% of the Qualified Export Sales pre-tax net income (50% method), or

 4% of the Qualified Export Gross Receipts

9 IC-DISC Benefit Example Using 50% Method

10 IC-DISC Commission Method

Foreign sales 20,000,000 Cost of goods sold (16,000,000) Gross Margin 4,000,000 Selling, general and administrative costs (3,000,000) Export sales net income 1,000,000 IC-DISC commission (greater of): 50% of export net income 500,000 4% of export gross receipts 800,000 IC-DISC commission 800,000 Federal tax savings (39.6%) 316,800 IC-DISC dividend 800,000 Federal tax cost (23.8%) 190,400 IC-DISC net tax savings 126,400

11 IC-DISC Commission Method

Neither the 4% gross receipts method nor the 50% method may be applied in a way that causes, in any taxable year, a loss to the related supplier.

12 Qualified Export Sales

Operating Company Qualifies For IC-DISC

Operating Company

IC-DISC Commission Sales Shareholder(s) IC-DISC

Export Customers Qualified Dividend

13 Qualified Export Sales

Supplier & Operating Company Qualify For IC-DISC U.S. Supplier Supplier IC-DISC

Operating Company

IC-DISC Commission Sales Shareholder(s) IC-DISC

Export Customers Qualified Dividend

14 Qualified Export Sales

Supplier, Operating Company & Distributor Qualify For IC-DISC U.S. Supplier Supplier IC-DISC

Operating Company

IC-DISC Commission Sales Shareholder(s) IC-DISC

U.S. Distributor IC-DISC Qualified Dividend Distributor Export Customers 15 Qualified Export Sales

Operating Company with Foreign Supplier DOES Qualify For IC-DISC Foreign Supplier

Operating Company (> 50% Value Added)

IC-DISC Commission Sales Shareholder(s) IC-DISC

Export Customers Qualified Dividend

16 IC-DISC Ownership

If the Operating Company is a Flow-Through Entity, potential owners of the IC-DISC are:  Individuals  Trusts  The Operating Company  Other Flow-Through Entities

If the Operating Company is a Non-Flow-Through Entity, potential owners of the IC-DISC are:  Individuals  Trusts  Flow Through Entities

17 IC-DISC

1. State of Incorporation 2. Incorporation Requirements 3. Incorporation Documents 4. Agreement(s) between Operating Company and IC-DISC

18 IC-DISC Incorporation

Incorporation Requirements

1. Establish Corporation 2. Single Class of Stock 3. IC-DISC Election (Form 4876-A) 4. Capitalization of IC-DISC of at least $2,500 5. Timing of Incorporation 6. Separate books from Operating Company

19 IC-DISC Incorporation

Other Documents Related To The IC-DISC

1. Incorporation Documents: Bylaws, Articles of Incorporation, Shareholder Agreements, etc.

2. Agreement(s) between Operating Company and IC-DISC: Sales Agent Agreement (Commission Agreement)

20 IC-DISC Ownership

Pass-through Entities (S-Corporations, LLCs and Trusts): Dividends pass through the corporation to the shareholders and are taxed at the Qualified rate of 15% - 23.8%.

Individual Shareholder(s)

Pass-through Exporting Company (Related Supplier) Payment To IC-DISC Qualified Dividend Reduces Taxable Taxed At 15% - Income at 39.6% 23.8%

IC-DISC

21 IC-DISC Ownership

C-Corporations: Avoid double taxation by having the IC-DISC owned by individual shareholders. Individual Shareholder(s)

Qualified Dividend Taxed At 15% - 23.8%

C-Corp Exporting Company (Related IC-DISC Payment To IC-DISC Supplier) Reduces Corporate at 34%

22 IC-DISC Ownership

Publicly Traded Operating

 Only real option is to have the IC-DISC owned by the Operating Company and use it as a tax deferral vehicle.

Large / Changing Shareholder Bases at Operating Company

 Flow-Through Entity – optimal to have Operating Company own IC-DISC and use it as tax savings vehicle

 C-Corp – Either use as deferral vehicle or have individual shareholders own the IC-DISC and change ownership accordingly

23 IC-DISC Ownership

Estate Planning: IRA

IRA Ownership Of IC-DISC • Accumulated IC-DISC income taxed at individual rates 15-39.6% when distributed • Assets in IRA invested tax-free • Roth IRA distributions not taxed to beneficiaries • Cases pending on whether tax on excess contributions is applicable

24 IC-DISC Ongoing Items

Annual Maintenance and Items To Adhere By

1. 95% qualified gross receipts test

2. 95% qualified export asset test

3. $2,500 capital at all times

4. Timely payment of commissions

5. 1120 IC-DISC and applicable Schedules

6. Maintain IC-DISC books

25 Tax Return & Filings

1. IC-DISC Election (Form 4876-A) 2. 1120 IC-DISC & Attached Schedules 3. Form 8404 4. Applicable State Filings

26 Identify Opportunities

1. Where does the company sell its products? Where are projects located if architecture and engineering firms?

2. Does the company sell to third parties or distributors?

3. Are the products exported by the company made in the U.S. or is 50% or more of the content derived from the United States?

4. Was the company qualified for the Extraterritorial Income Exclusion in years past? If so, it likely qualifies for an IC-DISC.

5. In order to capture tax benefits with an IC-DISC, the IC-DISC must already be formed. So be proactive.

27 Ways IC-DISC Consultants Can Help

 IC-DISC Structural Analysis & Consulting  Incorporation & Agreements  IC-DISC Compliance  IC-DISC Calculations and Tax Benefit Maximizing Analysis  Ongoing Consulting and Advisory Services  Year-End Planning  Year-End Analysis and Tax Benefit Maximization  IC-DISC Tax Returns & Forms

28 Contact

Please feel free to contact us with any further questions.

Clarke, Snow & Riley, LLP Thomas Clarke 25 Newport Avenue Extension [email protected] Quincy, MA 02171 Kamran Khan TEL (617) 773-9944 FAX (617) 773-9292 [email protected] www.csrk.com

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