Understanding Treas. Reg. §1.994-1(e)(3)(ii): Offsetting Entries for IC-DISC Commissions and Qualified Dividends

The Interest Charge Domestic International Sales Corporation (IC-DISC) regime offers significant tax benefits for U.S. exporters, but it comes with strict compliance requirements. One area that often raises questions is how commissions paid by a related supplier to an IC-DISC can be satisfied, particularly through offsetting accounting entries. Treas. Reg. §1.994-1(e)(3)(ii) provides important guidance on this topic, allowing for flexibility in the payment process while ensuring the integrity of the IC-DISC structure.

Table of Contents

1. What Does Treas. Reg. §1.994-1(e)(3)(ii) Say?
2. How Do Offsetting Entries Work?
3. Why Is This Important?
4. Key Authorities and Guidance
5. Best Practices for Compliance
6. Conclusion

What Does Treas. Reg. §1.994-1(e)(3)(ii) Say?

The regulation addresses the timing and form of payment for commissions or transfer prices between a related supplier (typically the operating company) and its IC-DISC. To maintain IC-DISC status, at least 95% of the corporation’s assets must be “qualified export assets,” which can include commissions receivable from the related supplier, but only if those commissions are “payable and paid” in a manner prescribed by the regulations.^1,^2

Treas. Reg. §1.994-1(e)(3)(ii) outlines several acceptable forms of payment, including cash, property, certain written obligations, and, crucially, offsetting accounting entries. This last method allows the commission receivable owed by the related supplier to the IC-DISC to be “paid” by offsetting it against an existing liability that the IC-DISC owes to the related supplier, such as a dividend payable.^3

How Do Offsetting Entries Work?

In practice, the related supplier records a commission payable to the IC-DISC, and the IC-DISC records a commission receivable from the supplier. If the IC-DISC also owes a dividend to the supplier, both parties can agree to offset these amounts through appropriate accounting entries. For example, if the IC-DISC is set to pay a dividend to its parent company (the related supplier), and the parent owes a commission to the IC-DISC, the two amounts can be netted against each other on the books.

It is critical that these offsetting entries are made within 60 days after the close of the IC-DISC’s taxable year. The entries must be reflected in the accounting records—not just on the tax return—to satisfy the regulatory requirements.^3,^4

Why Is This Important?

Properly executed offsetting entries allow the commission receivable to be treated as “paid,” which means it can be counted as a qualified export asset for purposes of the 95% asset test. This is essential for maintaining IC-DISC status and the associated tax benefits. Failure to make the offsetting entry within the required 60-day window, or failure to properly document the transaction in the accounting records, can result in the commission receivable not being treated as a qualified export asset. This could jeopardize the IC-DISC’s qualification and its tax advantages.^4,^5

Key Authorities and Guidance

The Tax Court case Gibbons Int’l, Inc. v. Commissioner is the leading authority interpreting this regulation. In Gibbons, the Tax Court addressed whether offsetting entries made after the close of the IC-DISC’s taxable year, but within the 60-day window, satisfied the “payment” requirement for commissions receivable to be treated as qualified export assets. The court held that the regulation requires an actual reduction of both the commission receivable and the corresponding liability (such as a dividend payable) on the IC-DISC’s books within the 60-day period. The court emphasized that merely netting the amounts on the tax return, or transferring the receivable to another asset account, is not sufficient. The offsetting entry must be a bona fide accounting entry that reduces both accounts on the books of the IC-DISC and the related supplier. The Gibbons decision underscores the importance of timely and proper documentation, as failure to make the required entries can result in the loss of IC-DISC status and its tax benefits.^4

IRS Technical Advice Memorandum 8721004 further confirms that offsetting entries are a valid form of payment, provided they are timely and properly recorded. Revenue Ruling 82-81 also references the need to comply with the timing and form of payment rules when amending returns to change the method of computing the commission.^5,^6

Best Practices for Compliance

• Ensure that any offsetting entries are made within 60 days after the close of the IC-DISC’s taxable year.^3
• Document the entries clearly in the accounting records of both the IC-DISC and the related supplier.^4
• Confirm that the offset reduces both the commission receivable and the corresponding liability (such as a dividend payable).^5
• Retain supporting documentation in case of IRS examination.

Conclusion

Treas. Reg. §1.994-1(e)(3)(ii) provides valuable flexibility for U.S. exporters using the IC-DISC structure, allowing commissions to be “paid” through offsetting accounting entries. However, strict adherence to the timing and documentation requirements is essential. By following these rules, companies can ensure that their IC-DISC remains in compliance and continues to deliver its intended tax benefits. If you have questions about IC-DISC compliance or need assistance with your accounting entries, consult with a qualified tax advisor.

^1 Internal Revenue Code §992(a)(1)(B).
^2 Treasury Regulation §1.994-1(e)(3)(i).
^3 Treasury Regulation §1.994-1(e)(3)(ii).
^4 Gibbons Int’l, Inc. v. Commissioner, 88 T.C. 1156 (1987).
^5 IRS Technical Advice Memorandum 8721004.
^6 Revenue Ruling 82-81.