IC DISC

An Old Idea Whose Time Has Come Again

Cut Your Tax Bill In Half!

Those of us who have been involved in exporting are aware of many government programs to “encourage” us to export more as a matter of social policy. Every dollar of goods we ship to a foreign country reduces our balance of payments deficit and strengthens the U.S. economy.

Unfortunately, many of the laws implemented to assist exporters are ultimately deemed to violate provisions of various fair trade treaties and agreements. One such victim in 2004 was the Extraterritorial Income Exclusion (ETIE). Many of us were able to reduce our tax bills simply by excluding a portion of our income attributable to foreign sales under certain circumstances. However, the World Trade Organization deemed that the ETIE violated international law and Congress repealed it. It is now being phased out and is completely eliminated after 2006.

However, there is an alternative export incentive provided by the tax code----it is the Interest Charge Domestic International Sales Corporation (IC DISC) This provision has been law since 1971. Under Internal Revenue Code Section 991 (which relates to the taxation of a DISC) states, “For purposes of taxes imposed by this subtitle upon a DISC, a DISC shall not be subject to taxes imposed by this subtitle.” In ordinary English-----The income earned by a DISC is exempt from taxation. The DISC itself can be the exporter. However, a DISC can also be an entity that receives commissions on export sales. Subject to certain rules and regulations, the commission can be 4% of export sales.

While accumulating tax free earnings is always attractive, this provision served more to defer taxes rather than a way to reduce taxes totally and as a result was rarely used. Until fairly recent changes in the tax law the IC DISC provided a fairly modest means of deferring income but there were minimal real savings because the highest corporate tax rate and the highest individual rate on dividend income were very close to each other.

However, once the rate on qualified dividend income was reduced to 15% (which has been extended to 2011) and given the repeal of the ETIE, it’s a whole new ball game. Income in a regular corporation can be taxed at a rate as high as 35%. Income in an IC DISC is not taxed. Dividends from an IC DISC are taxed at 15% Of course there are all sorts of permutations and types of entities.

Simply stated, an IC DISC enables an exporter to convert income that would be taxed at a rate of 35% to income taxed at 15%.

One thing that we like is that it is possible to generate significant savings even with relatively small sums of money involved. For example, if exports were $5,000,000. The exporter could pay the IC DISC a commission of $200,000. When this amount was distributed and taxed as a dividend at 15% the tax would be $30,000 as opposed to being taxed as ordinary income at a 35% rate which would total $70,000. Tax savings: $40,000!

Given that we are dealing with the IRS, it will come as no surprise that there are rules, regulations, procedures, elections and forms to fill out to make this all a reality. There are certain assumptions made in the preceding discussion that due to space limitations are not detailed but without which the outcome would not be achieved. We recommend that you consult with a professional advisor before proceeding.

For more information on IC -DISC’s you can go to www.dsbcpas.com/services, or you may call our office at (603)524-0507 and ask to speak with Scott or Chris. Given the right conditions, it could be very worthwhile.

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