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IC-DISCs as a Wealth Transfer Strategy

STEPBy: Christine BallardJune 15, 2016

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WHAT IS AN IC-DISC?

Interest Charge Domestic International Sales Corporation (“IC-DISC”)

o Allows IC-DISC shareholders to defer tax on export related income

o No federal taxation at the IC-DISC levelo Taxes deferred until the income is distributedo IC-DISC shareholders are required to pay interest

on the deferral of income

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WHY SHOULD YOU CARE?

IC-DISC reduces shareholder’s tax liability o Ordinary income can be converted into qualified

dividend taxed at preferential tax rates when distributed to IC-DISC shareholders

Exporting company can pay IC-DISC a tax deductible commission

o The IC-DISC can distribute the commission to its shareholders in the form of qualified dividend Exporting company must have taxable income

Tax rate reduction usually about 16%

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COMMON USED BY

US-based manufacturers and value added assembly operations

Distributors of US-manufactured products Food and agriculture exporting nuts, apples, wine, etc. Recyclers US-based architects and civil engineers with foreign

projects

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WHO CAN BENEFIT?

Taxpayers can use IC-DISCs to get tax incentives available to manufacturers, producers, resellers, exporters of goods:

o that are produced in the US;o with ultimate destination outside the US (sales to

unrelated party); ando where the cost of foreign content does not exceed

50% of the sales price

Entities that sell “export property”

IC-DISCs are widely used by owner-managed and family-owned businesses

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USES IN FAMILY WEALTH TRANSFER

Tax rate arbitrage opportunity

Converts ordinary income to qualified dividend, taxed at capital gain rates

Ability to push income and cash to another generation

Set-up usually not considered a gift

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SETTING UP AN IC-DISC

IC-DISC must be set up as a separate entityo Incorporated as C corporation o Election has to be made to treat entity as IC-DISC

(Form 4876)o Election must be filed within 90 days of the

beginning of tax year in which the election will take effect

o Single class of stocko Minimum capital $2,500 o Commission agreement between IC-DISC and

exporter

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COMMON STRUCTURES

Related SupplierRelated Supplier

IC-DISCIC-DISC

ShareholderShareholder ShareholderShareholder

Commission QualifiedDividend

IC-DISCIC-DISCRelated Supplier(C Corporation)Related Supplier(C Corporation)

ShareholderShareholder ShareholderShareholder

Commission

QualifiedDividend

Example 1 Example 2

Taxed at preferential

rate to shareholdersDeductible to

supplier

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COMMON STRUCTURES

LLCLLC

IC-DISCIC-DISC

Shareholder(Patriarch)

Shareholder(Patriarch)

HeirsHeirs

Commission

QualifiedDividend

Example 3

Related SupplierRelated Supplier

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DETERMINING THE COMMISSION AMOUNT Two primary methods may be used to determine the

commission paid to IC-DISCo 4% of the “qualified export receipts” (simple

method);o 50% of the combined taxable income of the

related supplier & IC-DISC from the sale of qualified export property (i.e. foreign source income)

The former is generally used when related supplier is selling a high volume with low profit margins

Commission (or reasonable estimate) should be paid within 60 days after the close of tax year

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EXAMPLE – TAX SAVINGSIC‐DISC Creates Tax Savings: Combined Almonds Walnuts

Export sales gross receipts $105,000,000  50,000,000  55,000,000 Cost of goods sold (94,500,000) (45,000,000) (49,500,000)Gross margin 10,500,000  5,000,000  5,500,000 Selling, general and administrative expenses (7,350,000) (3,500,000) (3,850,000)Combined taxable income 3,150,000  1,500,000  1,650,000 

% Foreign 90% 80%

IC‐DISC commission, greater of:50% of export sales net income $    1,335,000  $     675,000  $     660,000 4% of export sales gross receipts $    3,560,000  1,800,000  1,760,000 

IC‐DISC commission (limited to taxable income) $    2,670,000  $   1,350,000  $   1,320,000 

Federal tax savings to exporter 39.60% 1,057,320 

IC‐DISC dividend $    2,670,000 Federal tax on dividends paid by IC‐DISC shareholder 23.80% (635,460)

IC‐DISC Federal net tax savings $       421,860 

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MAINTAINING IC-DISC STATUS

The IC-DISC must meet the following requirements annually

o 95% or more of the gross receipts are “qualified export receipts”

o The adjusted basis of the qualified export assets meets or exceeds 95% of the total adjusted basis of all assets held by the IC-DISC

o The IC-DISC maintains only one class of stocko The par value of the stock is at least $2,500 for each

day of the tax yearo The IC-DISC maintains separate books and recordso The election to be an IC-DISC is in effect for the tax

year

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MAINTAINING IC-DISC STATUS

Qualified export assets under §993(b) include:o Export propertyo Assets used primarily in connection with the

sale, lease, or other specified activities relating to qualified export property, and in connection with performing certain services

o Sufficient cash required to meet the working capital requirements

o Subject to limitations, amounts on deposit in the US to acquire other qualified export assets

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CALIFORNIA CONSEQUENCES

FTB Ruling 2015-02

“Unwinds” IC-DISC transactions

IC-DISC files its own California return

IC-DISC pays only $800 minimum tax

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THANK YOU

ChristineBallardCPA,MSTPartner,NationalTaxInternationalTaxServices

MOSSADAMSLLP635CampbellTechnologyParkwayCampbell,CA95008D(408)558‐4338T(408)558‐7500C(703)328‐4180christine.ballard@mossadams.com