For many years, the federal income tax laws have included tax incentives in one form or another to encourage US companies to sell goods overseas. From 1971 to 1984, exporting companies were able to set-up and utilize a domestic international sales corporation (“DISC”) to reduce federal income tax. In 1984 a new more advantageous incentive called the foreign sales corporation (“FSC”) was introduced and the DISC, while still available fell into disfavor. The FSC rules have since been repealed and new rules authorizing the establishment of interest-charge DISCs have been enacted. The use of an interest-charge DISC (“IC DISC”) is especially advantageous for exporting companies since the qualified dividend rate is significantly lower than the ordinary income tax rate. Yet many companies that have significant export sales have overlooked the significant tax savings that can be achieved using an IC DISC. Further, even companies that have adopted an IC DISC may not be utilizing it in the most effective manner.
An IC-DISC can provide a significant tax benefit on every qualified export sale, but only if the IC-DISC is properly set-up prior to the sale transaction. When using an IC DISC, the exporting company pays a sales commission to the IC DISC in an amount not greater than 50% of export income or 4% of export sales. This sales commission is deductible by the exporting company, but is not taxable to the IC DISC. The owners of the IC DISC (generally the same people who own the exporting company) then have two choices.
Choice 1: Have the IC-DISC distribute the sales commission to its shareholders as a dividend at the qualified dividend rate (20% for most taxpayers).
Choice 2: Have the IC DISC hold the sales commission and defer payment of tax on the sales commission amount, paying interest on this amount at the currently very low base period T-bill rate. For 2015 the annual rate was less than 1 percent (0.2402874%).
The taxpayers win either way. But deferring payment of tax, while paying super low interest, presents the opportunity to leverage the initial tax savings into even bigger financial gains.
Example of How an IC DISC Works with an “S” Corporation Exporting Company:
|Cost of Goods Sold||1,000,000|
|Other Export Related Expenses||150,000|
|Export Income Before IC DISC Commission||350,000|
|IC DISC Commission (50% of Export Income)||175,000 *|
Export Income After IC DISC Commission 175,000 **
*The S Corporation Shareholder pays income tax at qualified dividend rate (20%) on $175,000 of DISC Commission WHEN DISTRIBUTED by the DISC
**The S Corporation Shareholder pays income tax at ordinary income tax rates on $175,000 of Export Income After IC DISC Commission
Use of an IC DISC can produce real tax savings this year, next year, every year. For more information on how to set up an IC DISC and save significant tax dollars please call Jeff Senney at 937-223-1130 or Jsenney@pselaw.com