Is your client’s company one of the many in the United States that is experiencing a rapid increase of exported goods? Exporting creates an opportunity to use a tax savings strategy by creating an Interest Charge – Domestic International Sales Corporation (IC-DISC).
Not just for large C-Corporations, an IC-DISC applies to small/medium pass-through entities as well. If your client’s company’s export revenue averages $1 million per year and/or is projected to be growing in the future, they should explore how an IC-DISC can result in a significantly lower tax bill for your client’s organization.
What is an IC-DISC?
An IC-DISC is a separate legal entity that elects IC-DISC tax status. This creates the opportunity for a company to convert ordinary income into dividend income. In high-income earners, this typically converts 39.6% income into 23.8% income. A key point is that this is a permanent tax savings which gives the IC-DISC a unique benefit over many other tax opportunities. When you are discussing strategies such as method of accounting or recurring item exception, these are only deferring taxable income to a different year. But if an IC-DISC saves $20,000 in tax dollars, that is money left directly in your client’s pocket or invested back into the business, and – oh yeah – all else being equal, that is an extra $20,000 saved every year!
So who and what exactly qualifies?
Anyone can set up an IC-DISC, but there is a cost benefit that needs to be analyzed. As mentioned previously, if exporting revenue nears $1 million, or exporting is a potential strategy, then an IC-DISC analysis is a necessity.
The types of produced goods in the U.S. that qualify include, but are not limited to:
- Architectural and Engineering companies
- Software companies
Better yet, the company producing these goods does not have to be the direct exporter. If the goods are produced and the end purchaser is in a foreign country, the goods can travel through a U.S.-based distributor. In the case of a distributor, both the manufacturer of the goods and the distributor can set up an IC-DISC, and both can get tax benefits from the same goods.
How would a service firm such as an Architectural/Engineering (AE) firm use IC-DISC?
The primary reason many A/E firms don’t set up these separate tax-exempt corporate entities is because they believe an IC-DISC is just for certain industry groups, such as manufacturers, who export tangible products. The reality is that the IC-DISC also specifically allows firms providing architectural or engineering services on foreign projects to utilize this strategy.
What do A/E firms need to know about how an IC-DISC works?
If your client’s firm is providing services for a project located or proposed for location outside of the U.S., revenue from that service can be utilized for IC-DISC savings. By using the IC-DISC vehicle, this new corporation can earn a profit generally equal to the higher of 4% of qualified export gross receipts or 50% of export taxable income of the firm. These profits are then distributed as dividends to the stockholders of the IC-DISC. Since these dividends are considered “qualified dividends,” the stockholder pays tax on them at the lower federal capital gains rates while the company gets a deduction at the higher ordinary tax rates. This rate differential can add to a significant and permanent tax saving.
Does this separate entity need to be run as its own company?
No, the beauty of the IC-DISC is that it is not required to maintain an office, hire employees, etc. In essence, the corporation is a shell, but rest assured it is a legal one that is worth the effort.
Could you provide some examples of architecture and engineering activity that would qualify?
Sure, qualified services include consultation, planning, design, drawings and specifications, feasibility studies, and supervision. It’s important to note that these services don’t have to be physically conducted outside of the U.S. As long as the end result is a project in a foreign country, your client’s work can all be done from the comfort of your client’s U.S.-based office.
Is this tax benefit only applicable to larger firms?
No – any firm regardless of size can and should take advantage of an IC-DISC. While there are revenue minimums, firm size alone will not impact your client’s ability to utilize this opportunity.
Is it too late at this point in the year to set up an IC-DISC?
Not at all, they can be set up at any time during the year. However, an IC-DISC is not retroactive, so you will only start to receive benefits after it is established. The key to maximizing the benefit is to set it up as soon as you know you will be working internationally.
What should any firm do first to determine if they qualify for an IC-DISC?
The mechanics of an IC-DISC are complex and often confusing to navigate. While we do not go too deep into the details here, an international tax professional can explain the ins and outs of this benefit and how it can deliver significant savings. The process from beginning to end can take time, so it is critical to do your client’s research and reach out to a professional if necessary to assist.
Mike Wilhelm, CPA