With supply chain disruption and recent economic hardship, minimizing taxes to maximize cash flow has become even more of an area of focus for businesses. For exporters, one cost-reducing option that might have been ignored previously is an interest-charge domestic international sales corporation (IC-DISC) structure, which can help reduce U.S. income taxes.
If you manufacture or export U.S. goods that have an ultimate destination outside the United States, an IC-DISC structure could be a powerful tool to reduce your tax liability. An IC-DISC is an export incentive that involves establishing a new company that’s exempt from federal, and many times, state taxation. The incentive was designed to encourage companies to enter global markets through exporting products or services.
An IC-DISC is often used successfully by manufacturers, distributors, automotive suppliers, architecture and engineering firms, software developers, and agricultural companies, but any organization with profitable exports should consider exploring this opportunity.
If you haven’t evaluated this option before, you may want to consider it. And, if you dismissed it in the past, you may want to reevaluate it in light of current circumstances. Lastly, if your business has already adopted this corporate structure, you may benefit from advanced strategies that can make an IC-DISC even more valuable.
What is an IC-DISC?
An IC-DISC is a tax-exempt corporation that generally has no employees or business activity. An exporting company is allowed to pay a commission to the IC-DISC based on the profitability and volume of its export transactions, and the IC-DISC then distributes its income to its owners as a dividend. The dividend, when received by an individual, should be a “qualified dividend,” which is generally taxed at preferential long-term capital gains rates. This change in rates can result in tax savings of up to $16,000 on every $100,000 in export profits, and potentially greater savings in certain fact patterns.
IC-DISC tax law changes
Most DISC structures result in tax savings through the tax rate arbitrage between ordinary income and the qualified dividend rate, or by allowing a C corporation to effectively deduct dividend payments. The rate changes enacted under the Tax Cuts and Jobs Act did reduce the tax advantages that this structure provides to some extent, but legislative and economic changes in response to the COVID-19 pandemic have served to restore some of the value to the IC-DISC strategy. Also bolstering some of the DISC’s value was a 2021 Ninth Circuit ruling that reinforced the value of a Roth IRA-owned IC-DISC structure.
Supply chain disruption and IC-DISC
With global supply chains facing disruption, many exporters have been forced to find new sources for the materials that go into the goods they send overseas. Because the IC-DISC commission calculation is based on percentages of net export income from products meeting domestic content thresholds, exporters who tapped into new domestic supplies may have increased their percentages of qualified export sales. For those who may have considered using this entity in the past and dismissed it, a significant onshoring of the supply chain into the United States could modify the commission calculation and tip the scales in favor of implementing an IC-DISC.
Section 174 amortization and IC-DISC
On Jan. 1, 2022, a provision of the Tax Cuts and Jobs Act (TCJA) took effect and altered the treatment of research and experimental (R&E) expenditures under Section 174 of the IRC (Sec. 174 expenses). Historically, businesses have had the option of deducting Sec. 174 expenses in the year incurred or capitalizing and amortizing the costs over five years. But under the new TCJA provision, taxpayers are required to capitalize and amortize these costs over five years for research conducted within the United States or 15 years for research conducted outside of the United States.
In many cases, this amortization will increase taxable income but can have an additional benefit to the IC-DISC calculation. This amortization will decrease the tax-deductible expenses of the company during the initial five years, which can increase the available IC-DISC commission deduction. This increase to the commission deduction can help offset the additional tax burden from the requirement to capitalize 174 expenses by converting some of the increase in taxable income to the preferential long-term capital gains rates instead of ordinary rates.
Advanced IC-DISC structures
In addition to the basic math of tax rate arbitrage and increased deductions, IC-DISCs also enable exporters to participate in more advanced strategies that can help to optimize their tax positions. With tax savings more important than ever, transaction-by-transaction optimization strategies may enhance the benefits of an IC-DISC. Eligibility and qualification for these advanced strategies will depend on the individual facts and circumstances of each taxpayer, but they should be part of the conversation when exporters discuss IC-DISCs with their tax advisors.
How we can help with IC-DISCs
An IC-DISC has specific requirements that must be met in the formation stage and on an annual basis to realize benefits. Our experts are dedicated to IC-DISC transaction analysis and preparation and have developed tools that optimize your potential savings.
