IC‐DISCInterest Charge – Domestic International Sales Corporation

Kevin Heyde, Mountjoy Chilton MedleyJames Seiffert, Stites & Harbison

January 19, 2011

Today’s Objectives

• Explain the tax benefits of an IC‐DISC to your company and shareholders

• Rules to qualify for IC‐DISC benefits• How to establish an IC‐DISC

– for our discussion today we will be discussing IC‐DISC that is a “Commission DISC” not a “Buy/Sell DISC”

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Should a Taxpayer be Considering an IC‐DISC?

• Would my company and shareholders benefit from an IC‐DISC?• Does your company export products?• Are products exported produced, grown or extracted from U.S. 

source (new or used) majority content of US value (>50% value U.S.)?

• Does your company provide services e.g. engineering or architectural services for construction project outside of U.S.?

• Is your company a pass through entity such as an S‐Corporation or Partnership?

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Legal Structure• Domestic corporation incorporated under the laws of 

any state or District of Columbia– One class of stock– Par or stated value of outstanding stock is at least $2,500 on each day of the taxable year

– Corporation has made an election to be treated as an IC‐DISC, executed by an authorized officer of corporation and ALL shareholders owning stock on the first day of IC‐DISC’s taxable year• Newly formed entity, filed within 90 days of beginning of the corporation’s first taxable year

• Existing entity, filed during the 90 days preceding the first day of the corporation’s taxable year

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Ineligible Entities • Entities that cannot elect IC‐DISC treatment, not an all inclusive listing:– Corporation exempt from paying taxes– Personal holding company– Associations that are not corporations but are taxable as a corporation

– Regulated investment company– S‐Corporation– An insurance company

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Additional Requirements• 95% of IC‐DISC’s receipts must be “Qualified Export 

Receipts”• 95% of the adjusted basis of its assets must be “Qualified 

Export Assets” at the end of its tax year• Have same tax year as primary shareholder• Maintain its own set of books and records• Cannot be a member of a controlled group with a 

Foreign Sales Corp (“FSC”)• Export sales prior to incorporation, capitalization and 

election to be treated as an IC‐DISC do not qualify for IC‐DISC benefit

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Qualified Export Receipts & Export Property• Qualified Export Receipts

– Gross receipts from• Sale, exchange …“export property,” ultimate destination and use outside of the U.S.

• Lease or rental of “export property” used outside the U.S.

• Commissions earned on the sale or rental of export property

• Services which are related and subsidiary to qualified sales

• Engineering or architectural services for construction projects located outside the U.S.

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Qualified Export Receipts & Export Property• “Export Property” is property:

– Manufactured, produced, grown, or extracted in the U.S. by person other than DISC

– Not more than 50% of fair market value of export property is attributable to imported materials into the U.S.

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Qualified Export Assets of IC‐DISC

• Qualified Export Assets that IC‐DISC can have on its balance sheet– Accounts receivable– Producer’s loans– Export property (i.e., inventory), buy/sell DISC– Export property assets, buy/sell DISC– Temporary investments of working capital

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IC‐DISC Owned Directly by Flow Through Entity

Business Profits & Dividends taxed to 

Shareholders

Individuals

S Corporation

IC‐DISC

100%

Dividend

Exports Sales

Commission100%

Non‐USCustomer

Non‐USRelatedCustomer

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Ownership Directly by Individuals

Commission

IndividualA

IndividualB

IndividualB

ExporterSupplierUSCo

IC‐DISCUSCo

IndividualA

Profits net ofCommissions Dividends

Non‐USCustomer

Non‐USRelatedCustomer

Sales

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IC‐DISC Tax Savings & Benefits• IC‐DISC is exempt from federal income tax• Exporter (Supplier) deducts commission paid to IC‐DISC, i.e. 

reducing taxable income flowing to shareholders taxed at 35%, tax savings re: deduction

• IC‐DISC pays dividend to its shareholders which is taxed at federal capital gains tax rate max. 15%

• Net federal tax savings to shareholders on commission deduction vs. dividend income (35% vs. 15%) yields 20%

• Annual deferral of federal income tax on up to $10,000,000 qualified gross receipts

• Potential for state and local tax savings• Potential Estate & Gift Planning opportunities

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Example of Tax SavingsS-Corporation with no IC-DISC S-Corp with IC-DISC

Domestic Export Total Domestic Export Total Dividend

Sales 6,000,000 2,000,000 8,000,000 6,000,000 2,000,000 8,000,000

Taxable Income before Commission (1) 600,000 120,000 720,000 600,000 120,000 720,000

Commission expense 50/50 method 80,000 80,000 80,000

Net federal taxable Income after Commission 600,000 120,000 720,000 600,000 40,000 640,000

Shareholder Level

Federal Tax at 35% 210,000 42,000 252,000 210,000 14,000 224,000

Federal Tax on IC-DISC Dividend 15% 12,000

Tax to shareholder 210,000 42,000 252,000 210,000 14,000 224,000 12,000

After Tax Cash available to shareholder 468,000 484,000(I) (II)

Minimum Federal Tax Savings (II) less (I) 16,000

Footnote: (1) greater of (A) or (B)

(A) 4% of Qualified export receipts ($2,000,000 * 4%) 80,000

(B) 50% of export taxable income from export sales ($120,000 * 50%) 60,000

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Operating the IC‐DISC• Export Sales made by Supplier to its customers, DISC is not involved• IC‐DISC is transparent to Customers• IC‐DISC earns commission on qualified export sales• Tentative commission paid by Supplier within 60 days of year end.• IC‐DISC distributes commission income earned to shareholders via 

a qualified dividend– IC‐DISC shareholders pay federal tax at capital gains rate maximum 

rate 15% (currently for 2011 and 2012)

• Final commission payment by Supplier made within 90 days of determination, preparation of tax return

• Tax return is filed on or before 15th day of ninth month following year end

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What is the “Interest Charge”• Commission to IC‐DISC defers Shareholder tax until 

commission distributed by the IC‐DISC, qualified dividend• IC‐DISC shareholder (owner) pays an “Interest Charge” to the 

IRS when DISC earnings are accumulated and not distributed– Calculated on Form 8804, filed separately with IRS: 

• Due no later than original due date of shareholder’s tax return, individuals April 15th, corporations March 15th

• Federal income tax at ordinary tax rates on Accumulated IC‐DISC income not distributed, approximately equivalent to retained earnings of IC‐DISC

• Interest charge rate is the Base Period T‐Bill rate published annually by IRS, September 30 of each year, (Rev. Rul. 2010‐28) set 2010 Base Period T‐Bill rate at .34 percent (.0034)

• Shareholder(s) avoid interest charge if IC‐DISC does not accumulated income

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Computation of Interest Charge2009 2010

Prior Year Current Year DISC Taxable income and earnings and profits for the year $ 150,000

Actual distributions during current tax year $ (60,000)

Accumulated DISC income - end of year $ 120,000 $ 210,000

Calculation of interest charge:

Accumulated DISC income prior year $ 120,000 Calculation of Excess Current year distributions Current year income $ 150,000 Current year distributions $ (60,000)Excess Current year distributions (negative) $ -

Current year deferred DISC taxable income $ 120,000

Assumed deferred tax liability @ 35% $ 42,000 Interest charge using current year Base Period T-Bill Rate 2010 0.0034

"INTEREST CHARGE" paid by shareholder on individual return (deductible interest) $ 143

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IC‐DISC Set‐up• Form a domestic corporation incorporated in any state or 

District of Columbia, need to consider state tax treatment of IC‐DISC– Draft and file Articles of Incorporation– Apply for Federal Tax Identification Number– Draft and adopt Corporate By‐Laws– Registered Agent

• Draft and execute DISC Commission Agreement• File federal election Form 4876‐A• Open bank account

– Contribute minimum capital of $2,500• Other matters related to establishment of business, e.g.

– Mailing address (PO Box, phone number, etc.)• Set‐up internal processes to track qualified export sales

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State treatment of IC‐DISC(specific rules of each state need to be analyzed further)

StateState Tax Treatment of entity that

elects to be an IC-DISC StateState Tax Treatment of entity that

elects to be an IC-DISCAlabama nontaxable - follows federal Montana nontaxable - follows federalAlaska nontaxable - follows federal Nebraska nontaxable - follows federalArizona taxable as ordinary corporation Nevada No tax

Arkansas nontaxable - follows federal New Hampshire taxable as ordinary corporation

Californiataxable included in waters edge

return combined return New Jersey taxable as ordinary corporationColorado taxable as ordinary corporation New Mexico nontaxable - follows federal

Connecticut nontaxable - follows federal New York nontaxable - follows federalDelaware nontaxable - follows federal North Carolina taxable as ordinary corporation

District of Columbia taxable as ordinary corporation North Dakota nontaxable - follows federalFlorida nontaxable - follows federal North Dakota nontaxable - follows federalGeorgia nontaxable - follows federal Oklahoma nontaxable - follows federalHawaii nontaxable - follows federal Oregon taxable as ordinary corporationIdaho taxable as ordinary corporation Pennsylvania taxable as ordinary corporationIlinois nontaxable - follows federal Rhode Island taxable as ordinary corporation

Indiana nontaxable - follows federal South Carolina nontaxable - follows federalIowa nontaxable - follows federal South Dakota nontaxable - follows federal

Kansas nontaxable - follows federal Tennessee taxable as ordinary corporationKentucky taxable as ordinary corporation Texas taxable as ordinary corporationLouisiana taxable as ordinary corporation Utah taxable as ordinary corporation

Maine taxable as ordinary corporation Vermont nontaxable - follows federalMaryland nontaxable - follows federal Virginia taxable as ordinary corporation

Massachusettstaxable as ordinary corporation

(special rules) Washington taxable as ordinary corporationMichigan taxable as ordinary corporation West Virginia nontaxable - follows federal

Minnesota taxable as ordinary corporation Wisconsin taxable as ordinary corporationMississippi taxable as ordinary corporation Wyoming No taxMissouri nontaxable - follows federal

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On‐going Compliance• Hold Board of Directors and Shareholder meeting in state of incorporation (e.g. adopt corporate resolutions to declare dividends)

• Record commissions received• Maintain books and records• File Form 1120‐IC‐DISC with IRS• File appropriate state tax returns• Ensure IC‐DISC rules are satisfied!

– The above is not intended to be a comprehensive listing

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Questions?

IRS Circular 230 Disclosure

As a result of perceived abuses, the Treasury has recently promulgated Regulations for practice before the IRS. These Circular 230 regulations require all accountants to provide extensive disclosure when providing certain written tax communications to clients. In order to comply with our obligations under these Regulations, we would like to inform you that any advice given in this presentation, including any attachments, cannot be used to avoid penalties which the IRS might impose, because we have not included all of the information required by Circular 230, nor have we performed services that rise to this level of assurance.