Now that President Trump has made it a priority to bring back manufacturing to the United States, now might be the time to consider an IC-Disc (Interest Charge Domestic International Sale Corporation). An IC-Disc reflects a special tax preference enacted by Congress to strengthen export sales. If a domestic corporation qualifies and elects to be treated as an IC-Disc, it is permitted to defer up to $10,000,000 from qualified export receipts per tax year.
The IC-Disc is a tax exempt entity, however, the shareholders are taxed on certain income of the IC-Disc whether or not it is distributed. The character of the commission income is a dividend; if not distributed during the year, it is a constructive dividend at the end of the year. Any remaining taxable amounts are taxed when actually distributed to the shareholder or where the corporation ceases to qualify as an IC-Disc.
Obviously, the IC-Disc provides an opportunity to defer income. To offset this tax advantage, the shareholders are subject to an interest charge based on the tax that would otherwise be due. The interest charge, reported on Form 8404, is the deferred tax liability multiplied by the base period T-bill rate. In this environment of low interest rates, the interest charged would be very low.
Tax benefit of an IC-Disc
The other main tax benefit of using an IC-Disc is that the difference between qualified dividend rates and ordinary income rates is the tax benefit afforded to the shareholders. This benefit can provide a substantial savings. A US exporter would be able to convert a portion of the export income into dividends thereby converting the tax rate from 35% to 20%. Example – exporting company XPE forms an IC-Disc. It pays and deducts commission to the IC-Disc. The commission reduces otherwise taxable income. The IC-Disc pays no tax on the commissions but still pay interest on the deferred income and the shareholders are not taxed until the earnings are distributed as dividends – currently 20%.
Qualifications of an IC-Disc
An IC-Disc must meet each of the following tests (1) it must be a domestic corporation; (2) it must have only one class of stock and must have stated value of $2,500 on each day of the taxable year; (3) it must elect disc status; at least 95% of its gross receipts must be export related; at least 95% of its assets, taken at adjusted basis at the close of the taxable year must be export related; and (4) the IC-Disc cannot be, among other things, an S corporation and will usually be a C corporation. The IC-Disc is often a separate entity typically established in a state which has favorable state law tax provisions.
There are transfer pricing rules which govern IC-Discs but generally, the IC-Disc can realize taxable income equal to 4% of the qualified export receipts on the sale by the IC-Disc plus 10% of the export promotion expenses, sometimes known as the “4% Method.” There are other intercompany pricing rules that could be used as well. As the IC-Disc itself is not a taxable entity, the shareholders are taxed on the earnings of the IC-Disc as dividends received on the last day of each tax year.
Notably, the EU has not challenged IC-Disc’s. Moreover, coupling IC-Discs with Section 1199 can achieve additional saving. Finally, an IC-Disc may be used for wealth planning.
If your company can benefit from forming an IC-Disc or if you have any questions regarding the matter, please contact me, Frank Brunetti, at 201-806-3364.