Exporters of U.S. made goods can get a free tax benefit equal to 10% or more of the profit on sales of those goods. This subsidy is available to manufacturers and distributors using an IC-DISC. It is available to non-public U.S. companies organized as C corporations, S corporations, partnerships, LLCs and sole proprietors.
Here’s how it works. The business entity (or the shareholders for a C corporation) forms a U.S. corporation which makes an election to be treated as a Domestic International Sales Corporation (DISC, often called an IC-DISC). The DISC and the business entity enter into appropriate agreements under which the business entity agrees to pay the DISC a commission on export sales for doing nothing. The DISC has no employeees or assets. The business entity gets a full deduction for the commission. The DISC is tax exempt on qualifying commission income. It then pays a dividend to the shareholder(s). The ultimate individual shareholders pay tax at capital gains rates on this qualifying dividend. This provides a Federal rate differential of up to 20%.
The DISC commission is limited to the greater of 4% of qualifying sales or 50% of net taxable income from qualifying sales. Qualifying sales includes profitable sales for use outside the U.S. of goods made in the U.S. The goods can be made by anyone, provided the non-U.S. content is less than 50% of the total sales price and the last part of the manufacturing is done in the U.S. However, sales made before the DISC exists can’t produce DISC benefits.
DISC commissions can be improved significantly under IRS rules. The commission is allowed only on profitable sales, so expenses related to loss sales are excluded in computing the 50% of profits limit. This “no loss” rule alone can often nearly double the tax savings. Taxpayers may electively use an overall profit percentage or a technique called “marginal costing” to improve the result. Other IRS approved techniques for improving the result also exist. These techniques increase the cost of making the calculation, but can greatly increase the tax benefit.
DISC is NOT cutting edge, aggressive, or risky. It works. 1,200 companies took advantage of it in 2006 according to IRS statistics and many more have since. The Bush administration tried to get it repealed, and Congress said they wanted to keep it. There’s no current repeal proposal being given serious consideration. The Obama administration has proposed keeping DISC and the rate differential. How long will DISC benefits last? Even the best crystal balls don’t have that answer.
Getting the agreements and calculations done in a manner that optimizes benefits requires experience. The DISC must also file a tax return each year, and Form 1120-IC-DISC is quite different than a regular corporate return.
If your company exports U.S. made goods, DISC can probably help you, but you need help to set up DISC right. A new corporation is needed, since the DISC election must be made at the start of a year. Also, the DISC and the business entity must have the appropriate agreements in place, and the DISC should have an “evergreen” dividend resolution.
Remember, savings from DISC start only when the new DISC is in place.