What Is an IC-DISC? – Understand the Export Tax Incentive
What is an IC-DISC? Corporations considering applying for tax-exempt status often wonder what it means to qualify for this tax exemption and what’s required. What is an Interest Charge Domestic International Sales Corporation and how does it work?
An Interest Charge Domestic International Sales Corporation or IC-DISC is an elected corporate entity based in the United States that sells products or services internationally and receives a tax incentive as an exporter. These corporations have less tax liability, can defer taxes, and pay less on federal income taxes.
This introduction to IC-DISC will explain this export tax incentive, its risks and benefits, the amount of federal tax corporations can save, and an actionable strategy to becoming an Interest Charge DISC and maintaining that status.
What Is an IC-DISC?
Congress introduced the Domestic International Sales Corporation or DISC status in 1971 to encourage the growth of the US economy through foreign exportation of goods and services.
A corporation can become an IC-DISC if its gross receipts within the last tax year qualify as qualified export receipts at a rate of 95 percent or higher.
Its qualified export assets must be worth 95 percent or more of the sum of its assets on an adjusted basis. Its stock class must be singular and $2,500 or higher. The Interest Charge DISC must also keep its own records separate from the corporation.
As an IC-DISC, the corporation receives a commission when it sells qualifying foreign products. The commissions are exempt from federal income tax. The corporation can accumulate up to $10 million in commissions every year before they must pay them as dividends.
The shareholders of the DISC will pay taxes on the dividends at a reduced rate. Their net investment income tax rate is 3.8 percent, and the capital gains tax rate is 20 percent, for a total of 23.8 percent.
Is IS-DISC Risky?
IC-DISC carries relatively low little risk. No tax-planning strategy is completely risk-free, but since its creation in the 1970s, the reduced tax rate has remained consistent, giving qualifying corporations a reliable way to reduce tax spending.
Compared to Foreign Derived Intangible Income or FDII, a tax deduction IC-DISC is often compared to, the latter holds much steadier. FDII, which applies to US-based companies specializing in intellectual property sold outside the country, will lessen its tax breaks by 2025.
IC-DISC is a permanent tax incentive, paving the way for a promising future.
If your corporation is interested in applying for IC-DISC status, you need assistance and services you can trust. Export Tax Management Inc. works closely with CPA firms to assist in filing international taxes.
How Does an IC-DISC Work?
Now that we’ve explored an IC-DISC definition, you may have another question. How does this tax exemption work?
A qualifying corporation must complete IRS Form 4876-A, Election to be Treated as an Interest Charge DISC. The form requests the corporation’s name, business address, Employee Identification Number or EIN, principal business classification, and phone number. The contact information for each shareholder must be included.
In Part II, the participating shareholders must consent to the IC-DISC status change.
After sending in the form, the corporation will operate as an Interest Charge DISC for at least the next tax year.
Only the exporter or shareholders can own the Interest Charge DISC. If you own a C corporation, you must create a separate entity when filing Form 4876-A, while if you’re part of a flow-through entity, you can add the IC-DISC as your subsidiary.
The Interest Charge DISC must have its own tax returns, accounting records, and bank account separate from the original entity, but the business can largely continue operating the same way.
When your corporation makes a foreign sale on a product or service, you pay the IC-DISC a commission. The commission is tax deductible and only paid at 50 percent of your net export income or four percent or more of your qualified gross receipts.
You can add the commission to your business expenses, lowering your taxable income by up to 37 percent.
When you reach the $10 million threshold for paying dividends, those go to the shareholders. The shareholders will pay a reduced tax rate of up to 23 percent.
How Much Federal Tax Can You Save?
What is an IC-DISC, and what can you save if you opt for one? The export commission rate is determined by whichever is higher, either 50 percent of the corporation’s qualifying export net income or four percent of its qualifying export gross receipts.
Let’s create an example to showcase how much a corporation can save.
A corporation has $5,000,000 in gross total sales and $3,000,000 in gross export sales for the 2022 fiscal tax year, which ended in December. The cost of goods sold was $1,000,000, its research and development expenses were $100,000, its admin/selling/general expenses were $7,000, and its other expenses were $15,000.
If paying a current marginal tax rate of 29.6 percent, the corporation has an estimated commission of $1,167,900 and a federal estimated tax saving of $112,118.
An Interest Charge DISC strategy is a must to amplify IC-DISC tax returns. The following information will help corporations properly file.
Confirm Your Eligibility
Your corporation must make the required foreign assets to qualify as an Interest Charge DISC. Further, you must have the appropriate corporate structure, creating the IC-DISC as a subsidiary if you or your shareholders are a flow-through corporation or a brother-sister corporate relationship as a C corp.
Know Your State Laws
The state laws for creating an Interest Charge DISC can have slight variations depending on which part of the country your business operates. Read up on your state laws to ensure you’re in compliance before proceeding.
Create Separate Books
The Interest Charge DISC must maintain its own records from the rest of your corporate entity, whether you’re an LLC, C corp, flow-through entity, or an S corp. This will reduce stress and improve your accuracy when filing your IC-DISC taxes.
Elect Within 90 Days
Upon determining your corporation will become an Interest Charge DISC, you should complete IRS Form 4876-A within 90 days. You must also file your taxes under Form 1120-IC-DISC, which we’ll discuss later.
Improve IC-DISC Each Year
If your corporation elects to continue as an IC-DISC, you should follow the above best practices and strive to improve your business standing yearly to maintain or increase your tax benefits.
Benefits and Advantages
IC-DISC benefits are extensive and can propel corporations to the next level of success. Here are the returns to anticipate.
Valuable for Estate Planning
Corporation owners must be future-minded, covering their bases for a smoother transition when the time comes. An Interest Charge DISC puts a corporation owner in an advantageous position regarding estate planning between the deferred dividends and lower tax rates for future corporation owners.
Prevents C Corp Double Taxation
C corporations are susceptible to double taxation through the required dividend payments to shareholders and corporate income taxes. Registering as an Interest Charge DISC grants C Corps the freedom to defer shareholder dividend payments, only paying corporate income taxes. Those will be at a lower rate.
Lowers Tax Liability
Since an IC-DISC can wait to distribute commissions into dividends, their tax liability is naturally lower. They will have to pay the deferred taxes eventually, so a corporation should ensure they have the capital to keep tax liability low.
The available capital a corporation will have available by deferring commission dividends can be used as working capital. Perhaps the corporation elects to expand advertising and marketing services for the export corporation (bearing in mind the export corporation pays for this) or finance the export corporation.
The capital can also go toward creating new products and services.
If your corporation is ready to explore your potential IC-DISC tax benefits, Export Tax Management Inc. can help. Start saving today.
About Form 1120-IC-DISC:
The 1120-IC-DISC is an IRS tax form all Interest Charge DISC corporations must complete. The full name of the form is the Interest Charge Domestic International Sales Corporation Return.
The first section of the form asks for the corporation’s DISC election year, name, business address, EIN, date incorporated, total assets, and business activity code number.
The corporation must list out any estate, trust, partnership, individual, or company that owned at least 50 percent of the Interest Charge DISC’s voting stock by the conclusion of the tax year. They must also mention intercompany pricing rules applied to gross income of 25 percent or higher and all taxable income.
Schedule A, Costs of Goods Sold, includes inventory at the start of the year, costs of labor, purchases, and inventory at the end of the year. Schedule B, Gross Income, details the corporation’s direct foreign sales, qualified export receipts, and interest on any producer loans.
Schedule C, Dividends, Inclusions, and Special Deductions, calculates the corporation’s dividends from foreign entities, total dividends, and qualified dividends. Section E, Deductions, covers warehousing, market studies, export promotion expenses, and more.
Schedule J, Deemed and Actual Distributions and Deferred DISC Income for the Tax Year, includes several parts:
- Part I: Deemed Distributions Under Section 995(b)(1), tallies taxable income and gross interest from prior sections.
- Part II: Section 995(b)(1)(E) Taxable Income, includes total qualified export receipts, statutory minimums, prorations, and more.
- Part III: Deemed Distributions Under Section 995(b)(2) includes annual installments of forms of distributable income.
- Part IV: Actual Distributions, requires the corporation’s other profits and earnings and other actual distributions.
- Part V: Deferred DISC Income Under Section 995(f)(3) is an accumulation of IC-DISC income.
Schedule L, Balance Sheets Per Books, includes qualified export assets, export-import bank obligations, working capital, funds awaiting investment, producer’s loans, trades receivable, nonqualified assets, accounts payable, capital stock, and total liabilities for shareholders’ equity.
M-schedules are for calculating losses, previously taxed income, accumulated IC-DISC income, and export gross receipts. Schedule N, Export Gross Receipts of the IC-DISC and Related U.S. Persons, details total export gross receipts as a percentage. All other information goes into Schedule O.
Filing Deadlines for Interest Charge DISC Corporations
An Interest Charge DISC corporation must file Form 1120 on the 15th day of the ninth month after its tax year ends. The exclusions are if the 15th is a holiday or weekend. In that case, the taxes must be filed within the next business day.
Why Export Tax Management?
Export Tax Management Inc. is an IC-DISC specialist. Your corporation won’t wonder, “what is an IC-DISC?” when you have us at the helm.
We can help you structure and incorporate Interest Charge DISCs into your corporation to increase your tax savings, extend tax referrals, and have more capital to work with. We’ll assist you in filing the requisite IRS tax forms and generate an IC-DISC Related Supplier Agreement.
We can ensure your Interest Charge DISC compliance and help you incorporate intercompany pricing methods to save the most on your federal income taxes.