“Sounds too good to be true.” It is the understandable reaction by business owners and accountants when they first hear about the export tax incentive for small and medium manufacturers known by the shorthand of “IC-DISC” — (Interest-Charge Domestic International Sales Corporation [IC-DISC]. The terrible name is probably one of the reasons many people aren’t aware of this tax incentive).
Fortunately, the tax savings are true. Unfortunately, while over 6000 small and medium businesses take advantage of the tax incentives of the IC-DISC, thousands more that are eligible are failing to do so.
The bottom line is that the tax laws provide an opportunity for a company to use an IC-DISC to have the tax on 50% of its export income reduced by more than 50%. Profits are taxed at the dividend rate (currently 15%) as opposed to ordinary income tax rates (top rate currently 35%). We have seen first-hand companies that have doubled their after-tax income from the use of the IC-DISC. The tax deal agreed to in December 2010 extended for two years the benefits of the IC-DISC (which have been in place since passage of the Jobs Act of 2004).
What businesses can benefit from the IC-DISC? This is the biggest misunderstanding by business owners – the net is cast much wider for IC-DISC than people think. I find it easiest to think of three types of businesses that potentially qualify for the IC-DISC tax benefit:
1) A company that directly exports goods it manufactures. Example: Company X manufactures widgets in Ohio and ships to Canada. Note: What counts as a manufactured good is also broader than many people realize – it can include software, films and many agricultural products.
2) A company provides architectural or engineering services that are conducted in the U.S. for a building/bridge built outside of the U.S. Example: An architectural firm based in Los Angeles designs a building that is built in China.
3) A company manufactures a good that is included in a product that is exported. This is probably the largest missed opportunity for businesses when it comes to the IC-DISC. IC-DISC tax incentives are also available in a situation where a company makes a component part that is included in a good that is exported. Example: Company Y makes tires that are included in a tractor that is shipped to South Africa.
Naturally big tax savings like this aren’t a walk in the park. In a nutshell you are creating a separate entity (or sometimes several entities to maximize the tax benefits) – the “Corporation” part of IC-DISC. The exporter pays commissions to the IC-DISC. The commissions are deductible to the exporter, and the deemed or actual dividend payment of the commission income in the IC-DISC is taxed to the exporter’s shareholders/partners at the 15% rate (as opposed to being taxed as ordinary income – ex. 35% rate).
At the end of the day, the exporter receives a deduction of 35% on the commission payments made to the IC-DISC and on the other hand only pays a 15% tax rate on the income repatriated from the IC-DISC. The bottom line – a permanent tax savings for U.S. exporters and their shareholders of 10% or higher of net export income. Oh happy day.
As mentioned, the first mistake companies make in regards to the IC-DISC is failing to even get out of the gate and realize that they are eligible to take advantage of the tax incentive. The second mistake companies make on the IC-DISC is failing to take full advantage of the tax incentives. Too often companies just do the “101” of IC-DISC and not recognizing the significant tax benefits by separating high margin from low margin streams of income.
We find that 8 out 10 businesses and commercial property owners are leaving money on the table every year.