Not only are international sales a great way to increase revenue for your company, but exporting domestically produced products also may create tax savings.
Selling goods in countries where the tax rates are lower than the United States is one way to go about it, but there’s a great tax incentive out there that can benefit even exporters operating in countries with tax rates higher than the United States.
And this option is available without even setting up a foreign business entity. Even more – it can provide big savings.
The Interest Charge – Domestic International Sales Corporation, or IC-DISC, is the last remaining export incentive available to U.S. exporters. It’s been around since 1984, but became popular when the Jobs and Growth Tax Relief Reconciliation Act of 2003 lowered the qualified dividends tax rate, making it far more attractive for exporters.
An IC-DISC is a domestic “paper” entity that does not require international employees, offices, or tangible assets. But under the IC-DISC, exporting companies are allowed to cite a portion of their sales as a commission to the IC-DISC, and then the IC-DISC shareholders only have to pay tax on the dividend income at a preferential rate.
Assume a manufacturer that generates approximately $2M of export net income currently pays $680,000 of income tax based on a 34% federal tax rate.
Step #1: The company creates a tax-exempt IC-DISC. The IC-DISC is a “paper” entity that does not require office space, employees, or tangible assets. In this example, the IC-DISC is set-up under the ownership of the individual shareholders of the exporting company.
Step #2: The exporting company pays the IC-DISC a commission. The IC-DISC commission may be determined as the greater of 50% of export net income or 4% of export gross receipts. The commission may be increased even more in certain instances. In this case, they pay a commission of $1M (50% of net income) to the IC-DISC.
Step #3: The exporting company deducts the commission amount paid to the IC-DISC from its ordinary income taxed at a 34% federal rate. As a result, the manufacturer now pays income tax of $340,000. The commission income for the IC-DISC can also be deferred from current taxation based on up to $10 million of qualified export receipts subject to a nominal interest charge on its shareholders. For 2015, the interest rate is about 2.4%.
Step #4: IC-DISC pays dividends of $1M to the shareholders of the Corporation. The shareholders pay tax on the dividend income, currently at a federal tax rate of 20%, or $200,000. (Note: Dividends above certain levels may also be subject to the 3.8% Medicare tax.)
Now the total tax paid is $540,000, realizing a $140,000 benefit by using an IC-DISC strategy.
Many different entity types can use the IC-DISC, including flow-through entities (S-Corps, partnerships, LLCs, etc.); and closely-held C-Corps.
Your company doesn’t even have to actually manufacture products to take advantage of an IC-DISC; you may still qualify if you simply export domestically produced products.
Some industries that have taken advantage of the IC-DISC include:
- Software Companies
- Engineering/Architectural firms working on buildings/structures in foreign locations
IC-DISC implementation and rules are complex, but the benefits can be significant. Contact us at Concannon Miller to learn more about your tax planning options for overseas sales.