IC-DISC Export Tax Incentive – What You Need to Know
IC-DISC export tax incentives can lessen tax liability via a commission mechanism, so eligible businesses heavily seek them. However, companies must understand the full extent of these tax benefits before applying. What are the IC-DISC export tax incentives, and how do they work?
IC-DISC export tax incentives are offered for businesses with a foreign sales presence but still based in the United States. Eligible businesses can tax some of their exported profits at a lower rate, known as a commission mechanism. Tax deferment is also available, allowing companies to improve their cash flow.
This guide to IC-DISC tax benefits will explain the incentive in full, its advantages, reporting and compliance requirements, and more.
A Brief Definition of IC-DISC (Interest Charge-Domestic International Sales Corporation)
An Interest Charge-Domestic Sales Corporation or IC-DISC export tax incentive does not receive taxes on its income. Instead, its shareholders are taxed when the income is distributed. Shareholders also face an interest charge on deferred tax liability.
IC-DISCs act as export business sales commission agents specializing in international sales. The tax code provision for IC-DISC incentivizes US-based businesses to use a commission mechanism to lower their tax liability.
DISC benefits were limited in 1984 when Congress adjusted its statutes. DISC tax incentives and deferrals were available only by paying an interest charge first. Also important was the reduction in benefits. Businesses had to make another DISC election, as the legislation terminated those that existed at the time.
This lowered the rate of DISC tax returns drastically from 1984 until 2006. In the 2020s, DISC tax returns are healthier than ever, beginning with an uptick in 2007 onward.
IC-DISC Qualifying Criteria
IS-DISCs must meet this criterion to qualify:
- A corporation must have made at least $2 million in foreign profit before considering this tax incentive.
- The tax year of the IC-DISC is the same for the principal shareholder having the greatest voting power by percentage. The IC-DISC should be elected for a tax year for either principal shareholder if the two have the same rate of voting power.
- An IC-DISC must have separate records and books from another corporation under the same owners.
- Its outstanding stock must be $2,500 or higher every day of the last tax year. New IC-DISCs must have that revenue from the day the IC-DISC status was elected and for subsequent days.
- It must only specialize in one stock class.
- The adjusted rate of qualified export assets must be at least 95 percent when adjusting all IC-DISC assets
- The IC-DISC must make its election 90 days before the taxable year begins.
- Export assets must be receivables or commission revenues.
- Up to 95 percent of the IC-DISC’s gross receipts should be commissions-based from their qualifying exports, which are exports manufactured in the US at a rate of 50 percent or higher.
- They must lease property made in the US for countries outside of it.
How Does the IC-DISC Export Tax Incentive Work?
Let’s venture further into IC-DISC export tax incentives. Under the commission mechanism, you would create a corporation that meets the classifications of an IC-DISC. The shareholders or exporter must own the corporation, with the owner determined by the exporter type.
For instance, an exporter who’s a flow-through entity can create an IC-DISC as a subsidiary. However, if they’re a C-corporation, the onus is on the shareholders to establish the IC-DISC. Common ownership between the IC-DISC and the shareholder’s company is critical.
The IC-DISC receives a commission payment, which varies depending on the rate of export gross receipts. The only export gross receipts eligible are those where at least 50 percent of the product’s value is manufactured in America.
The commission payment lowers the IC-DISC’s taxable income, which means receiving tax breaks. Further, the IC-DISC does not have to pay federal taxes on their commission payments.
Instead, the IC-DISC pays a tax-deductible commission, or qualified dividend, to the shareholders.
For example, a manufacturer receives a corporate tax rate of 35 percent, but through IC-DISC tax incentives, the shareholder pays their qualified dividend income at 20 percent. This leads to tax savings of 15 percent.
Export Tax Management Inc. specializes in IC-DISC incorporation, implementation, and compliance. Contact our experts today to explore your future as an IC-DISC.
Advantages of IC-DISC for Exporters
Why do exporters seek IC-DISC tax incentives? Here is an overview of the benefits.
Exporters seeking tax benefits through IC-DISC incentives are better positioned to be competitive. They can expand their stage to the world economy, increasing their rate of export sales and strengthening their company as they broaden their approach.
Tax incentives for exporters like IC-DISC can lead to substantial tax savings, the biggest perk. IC-DISCSs are tax-exempt and don’t pay federal income taxes on commissions, with the commissions turning taxable after the owners receive dividends from the IC-DISC.
The rate paid on the taxable dividends doesn’t exceed 23.8 percent, which accounts for a net investment income tax rate of 3.8 percent and a capital gains tax rate of 20 percent.
In the 2020s, the marginal individual income tax rate is around 37 percent. However, an IC-DISC export tax incentive can drop to 29.6 percent, especially with a qualified business income deduction.
This allows flow-through entities using this tax incentive to lower tax rates to under 23.8 percent.
The money an IC-DISC saves through deferring and reducing its tax amounts and the increased cash flow from received commissions enables it to use the money however it chooses. For example, the IC-DISC can take out a larger loan or use the funds to pay directly for expanding its business.
In the latter case, an export business can fund itself. There’s no need to go through the stressful loan application process, pay back a bank, or accrue interest.
Expanded Export Services
An IC-DISC can also use its increased cash flow to broaden its services. Perhaps the company introduces a new product or service or funnels the money into an advertising or marketing campaign to grow its business. The possibilities are endless, but all positive.
The freedom to retain a commission and defer taxes allows an IC-DISC to hold onto export sales of more than $10 million annually before paying the interest payments. The above paragraphs illustrate that the taxes cannot be indefinitely deferred, but the corporation’s funding is widely beneficial.
Export Tax Management Inc. has completed more than 3,000 IC-DISCs and has accrued many happy clients. Join our 50+ CPA firm partners by contacting our experts about your IC-DISC export tax incentive today.
IC-DISC Compliance and Reporting Requirements
The benefits of an IC-DISC are only available to businesses that comply with the rules. First, we’ll provide an overview of those rules, then explain the reporting protocols.
IC-DISC Compliance Requirements
You’ll recall that an IC-DISC must keep its financial records separate from other corporate entities, such as a secondary business, but the compliance requirements run deeper than that.
An IC-DISC must pass a qualified export receipt or QER test, which accounts for all gross receipts from selling export property, including by principal commission agents under the DISC. The principal does not have to be a related supplier.
The IC-DISC’s gross receipts rate during an average tax year should contain 95 percent qualified export receipts to pass the QER test.
An IC-DISC must also undergo a qualified export asset or QEA test. Under this test, an IC-DISC’s qualified export assets should be within 95 percent of the adjusted asset basis sum by the cessation of the tax year.
IC-DISC Reporting Requirements
Utilizing the IC-DISC export tax incentive entails reporting. For instance, the corporation must complete the form IRS 1120-IC-DISC, Interest Chart Domestic International Sales Corporation Return.
The form asks for gross income, cost of goods, total income, deductions, taxable income, net operating loss deductions, special deductions, and an optional refundable credit, which applies to corporations paying federal fuel tax.
Even if a corporation isn’t required to pay taxes due to the IC-DISC export tax incentive, they must still file taxes annually, a trademark of good business practices. They must keep records carefully, accurately, and annually.
Evaluating IC-DISC Suitability for Your Business
Has learning about IC-DISC export tax incentives inspired your business to look further into them? You must first determine your suitability by considering these factors.
- Can your corporation apply for IC-DISC status?
- Does your corporation meet the criteria for IC-DISC tax incentives?
- Can your corporation pass QER and QEA tests?
If you believe that IC-DISC status is the right call for your business, you can’t afford to work with anyone less than the experts. Export Tax Management Inc. has saved over $250 million for its clients with our services, including transaction-by-transaction optimization and more.
Comparison with Other Tax Incentives
How does an IC-DISC export tax incentive stack up against other tax incentives like FDII
With IC-DISC explained, it’s only fair to delve deeper into FDII and how it works.
FDII is short for Foreign Derived Intangible Income. It’s a specialty earnings category from selling intellectual property products, including but not limited to trademarks and patents. Under an FDII, a corporation operates in the US and has IP rights in the country but makes IP-related sales outside the US.
With an FDII, the above sales enable a corporation to reduce its tax rate, with a standard rate of 13.125 percent. The introduction of FDII accompanied America’s shift to a territorial system from a worldwide one.
The FDII aims to motivate more businesses to hold IPs within the US.
An FDII operates a lot like a GILTI, short for Global Intangible Low Tax Income. A GILTI is a tax calculation that produces a max tax level based on the foreign earnings of a multinational corporation in the US.
GILTI came about in 2017 when the US introduced the Tax Cuts and Jobs Act. Since the TCJA can increase tax burdens for foreign profits, GILTI counteracts it, in a way. It also covers trademarks, patents, copyrights, and other intangible assets for the US’s switch to terrestrial taxes.
Getting back to FDII, a corporation can deduct a tax rate of 37.5 percent from their taxable income, reducing the dollar rate to 13.125 percent.
The difference between IC-DISC and FDII boils down to restrictions. FDII is not as limiting, as corporations needn’t have manufactured their products in the US as IC-DISC requires. The product also needn’t have been improved in the US.
However, both can offer tax incentives, so whether you should choose an FDII or IC-DISC depends on where you manufacture your goods. If it’s in another country despite being headquartered in the US, look into an FDII. Those corporations that make products in the US should consider an IC-DISC.
Book a Consultation Today for Your IC-DISC Export Tax Incentive
An IC-DISC export tax incentive helps qualifying companies incur more income by deferring tax payments and earning a commission. You must pass eligibility tests and have the right corporate structure to apply, but the benefits are more capital, the financial freedom to expand your product roster or further your business, and an increased sense of competition.
Export Tax Management Inc. are IC-DISC tax experts. Schedule a consultation with us to discuss your tax incentives and how you can begin enjoying perks today.