President Trump has made it a campaign priority to bring manufacturing back to the United States. But U.S. manufacturers and distributors may not be aware of an often overlooked tax advantage they have available right now.
President Trump has made it a campaign priority to bring manufacturing back to the United States. While details are yet to emerge on tax and trade policy proposals from the new administration, there is a potential tax saving opportunity that U.S. manufacturing and distribution businesses may not be aware of - and could take advantage of in 2017.
For qualifying companies, IC-DISC (Interest Charge Domestic International Sale Corporation) is a special tax benefit enacted by Congress to strengthen U.S. export sales. As global trade increases and competition squeezes profits, many U.S. exporters will look for ways to increase tax savings. One of the strategies for increasing cash flow from export sales is establishing an IC-DISC.
How do IC-DISCs work?
The IC-DISC offers the potential to save tax dollars on qualifying export sales. By establishing a new corporation electing to be taxed as an IC-DISC, taxpayers can pay and deduct a commission paid to the IC-DISC.
The IC-DISC, by law, isn’t taxed on qualifying income. Thus, 100 percent of that company’s earnings can be distributed to shareholders. The IC-DISC creates a tax benefit by reducing combined taxable income below the standard 39.6 percent individual rate, taking advantage of the dividend tax rates.
The IC-DISC pays no tax on the commissions. It may be subject to a differed interest charge. The IC-DISC shareholders are not taxed until the earnings are distributed as dividends. Qualified dividends are currently taxed at the 23.8 percent federal capital gains tax rate (3.8 percent Medicare tax on net investment income applies to distributions from the IC-DISC).
Let’s review a hypothetical example of a qualifying company that uses IC-DISC to offset $500,000 from operating income into an IC-DISC distribution.
The result is a net benefit of 15.8 percent of the IC-DISC profit. In this example, the company has the opportunity for $79,000 of cash flow benefit through tax savings. Business owners not active in the business may be able to receive a 19.6 percent net benefit.
Who can benefit?
- Manufacturers and distributors that directly export qualified products
- Manufacturers and distributors that sell products that are destined for use overseas
- Corporations and pass-through entities who export qualified products
- Architectural and engineering firms who work on projects that will be constructed abroad
In general, to qualify for IC-DISC benefits, products must be produced, manufactured, grown or extracted in the U.S., contain no more than 50 percent foreign content and be held for sale or lease in the ordinary course of business for direct use, consumption or disposition outside the United States. If you are exporting U.S.-produced goods, you should consider the benefits of an IC-DISC to take advantage of the available permanent tax savings.
The Internal Revenue Code and U.S. Treasury regulations provide numerous ways to calculate the permissible profit for the IC-DISC. The simplest methods to calculate the permissible profit / commissions (can be either):
- 50 percent of the combined taxable income of the related supplier at the IC-DISC
- 4 percent of the gross sales receipts
Sounds great! So what’s the catch?
- Establishing an IC-DISC is a complicated process that involves identifying qualifying export receipts, meeting qualified export receipts and qualified export asset tests, calculating the commission under available pricing methods and preparing accounting records and income tax returns. The added set-up, annual computational and compliance costs must be compared to the expected tax savings.
- 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.
How do you find out if this is right for your business?
The bottom line: If the potential tax savings (as a result of your level of exports and profitability) exceed the IC-DISC startup and ongoing operating costs, then an IC-DISC structure may be right for you.
Now is a good time to review your options. Seek out a tax expert knowledgeable about all facets of IC-DISC to discuss your specific situation. For more information or to contact Paul Simons, go to www.dsb-cpa.com/tax
Paul Simons (J.D., M.B.A., and CPA) is a Tax Principal at DS+B | CPAs + Business Advisors in Minneapolis. He provides privately held business owners and executive teams with ongoing tax guidance that comes from an in-depth understanding of their business and objectives. Paul’s expertise includes corporate transactions, executive compensation, mergers and acquisitions.