IncentiveStockOptionsMayNotBeAllThatTheySeem

Equityisanimportantcompensationtoolforemployerstocreatealignment,incentivizeperformance,buildlong-termvalue,andcontrolthecashcostofcompensation.

Thereareseveraltypesofequitycompensationarrangements,eachwithdifferenteconomicandtaxattributesthatcaninfluencehowandwhentheyareused.Dependingonthesituation,somearrangementscanfavortheemployerovertheemployee,andsometheemployeeovertheemployer.Thetaximplicationsofincentivestockoptions(ISOs)canvarydramaticallydependingonhowandwhenanemployeeexercisesandmonetizesanaward.

Onceapopularequitycompensationarrangement,ISOshavedecreasedinrelativepopularitysincetheearly2000sinfavorofrestrictedstockarrangementsandnon-statutorystockoptions(NSOs).However,intoday’smarketISOsareincreasinglybeingutilizedbyventureorprivateequity-backedprivatecompanies.Withthisriseinuse,itis

importanttounderstandthecomplexitiesandissuesfacedbyemployeesexercisingandmonetizingISOsintoday’sacquisition-focusedenvironment.

PotentialBenefitsThetaxtreatmentofanISOistypicallybeneficialtoanemployeerelativetootherequitycompensationarrangements.UnlikeISOs,bothNSOsuponexerciseandrestrictedstockarrangementsuponvestinggenerallycreatetaxablecompensationtotheemployeesubjecttoincometax,socialsecurityandMedicaretaxwithholding.Conversely,withISOsthereisnotaxablecompensationtotheemployeeprovidedthattheemployeeholdsthesharesreceiveduponexerciseforatleasttwoyearsaftergrantandoneyearafterexercise.Employeesmeetingtheaboverequirementsaretaxedatfederallong-termcapitalgainsrates(generally23.8%includingthenetinvestmentincometax)whenthesharesaremonetizedafterbeingheldformorethanoneyear.Duetothisfavorablerate,employeesgenerallypreferISOs.However,severalothercomplexandoftenoverlookedissuescanarisewithrespecttoISOsthatnegatepotentialbenefitstotheemployee.

PotentialDrawbacksOneconsiderationwithrespecttoISOsisthealternativeminimumtax(AMT).ISOscanhavesignificantAMTimplicationsthatareoftenmisunderstood.Whilethe2017taxreformrepealedtheAMTforcorporations,AMTremainsineffectforindividualtaxpayers.WhiletheexerciseofISOsdoesnotgeneratetaxablecompensationforregulartaxpurposes,thespreadbetweenthefairmarketvalueofthestockandtheexercisepriceonthedateofexercisegeneratestaxableincomeforAMTpurposes,potentiallysubjectingtheemployeetoAMTof26%or28%intheyearofexercise.

AsidefromthisrathermechanicalAMTissue,severalcommoncorporateeventscancontributetoalossofthebeneficialtaxtreatmentofISOs.Often,employeesexercisingISOsendupdisposingofthesharesinadisqualifyingdisposition(adispositionlessthantwoyearsfromthegrantdateandlessthanoneyearfromtheexercisedate)becausetheoptionexerciseisdoneinconnectionwiththesaleofthebusiness.Similarly,employeesmayreceiveanoptionterminationpaymentofcashinlieuofexercisingtheoptionaspartofasaletransaction.Inthesescenariostheemployeewillrecognizecompensationincome.Inaddition,anoptionterminationpayment(butnotadisqualifyingdisposition)isalsosubjecttoFICAtaxes.

AnotheroftenmisunderstoodandcomplicatingfactorofISOsistheannual$100,000aggregatevaluelimitation.Underthislimitation,theamountofoptionsthatqualifyasISOsisbasedontheexercisepricetimesthenumberofoptionsthatbecomeexercisableforthefirsttimeinacalendaryear.IftheaggregatevalueofISOsthatfirstbecomeexercisableinanyyearexceeds$100,000,theexcessoptionsaretreatedasNSOs.Thoseemployeesreceivinglargegrants,orgrantsinthemiddletolaterstagesofventureorprivateequityownershipwhensharevaluesmaybehigher,tendtoexceedthislimitationforpartormostoftheISOaward.Furthermore,manyISOawardscontainanearlyexerciseprovisionwhichallowstheemployeetoexercisealltheoptionsatanytimefortaxpurposes,eveniftheoptionsaresubjecttovestingovertimeundertheaward.Whenearlyexerciseprovisionsarepresentstartingatdateofgrant,theoptionsaretreatedasexercisableimmediatelyupongrant,andthe$100,000limitationisappliedatthattimetotheentireaward.ManyemployeesmaynotrealizepartormostoftheISOgrantisimmediatelyclassifiedasanNSO,potentiallyleadingtosurpriseatthetimeofexerciseorwhentheyreceiveaFormW-2attheendoftheyearreportingthetaxableordinaryincome.Alsonote,theaccelerationofvestingmayalsocauseISOstobetreatedasNSOs.

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Earlyexercisefeaturescanbecommon,becauseanemployeemaybeabletomitigateAMTbymakingaSec.83(b)election(forAMTpurposes)whenthevalueofthecompanyiscurrentlylow,butexpectedtogrowquickly,andcanreducethepotentialimpactofadisqualifyingdispositionintheeventofasale.However,aSec.83(b)electioncarriesadditionalrisk,asthereismoreuncertaintyregardingthecompany’sprospectsearlyinitslifecyclewithrespecttotheemployee’scapitalthatisnowatrisk(strikepriceandAMTliabilitypaid),comparedtonocapitalatriskinholdingtheISOuntiltheemployeehasmorevisibilityintothecompany’sfuture.

TheTakeawayIncentivestockoptionsmayseemlikeagreatchoicetoprovideemployeeswithincentivetogrowlong-termvalueandenjoybeneficiallong-termcapitalgainstaxratesupondispositionoftheshares.However,intoday’stransaction-focusedenvironment,employeesholdingISOsoftendonotmeettheholdingperiodrequirements,resultingindisqualifyingdispositionsoroptionterminationpaymentsthatgenerateordinaryincome.Furthermore,theAMTimpactandcomplexitiessuchasthe$100,000annuallimitationcanalsonegatesomeofthetaxbenefitofthesearrangements.Employersmusttaketheseconsiderationsintoaccountgiventhespecificfactualsituationoftheirbusinesswhenevaluatingequitycompensationarrangements.Aftersuchconsiderations,ISOsmayprovetonotbewhatwasintended.

  

 

  

ConsiderationsofPrivateEquityFundClawbackLiability

AspreviouslydiscussedinStructuringaCarriedInterest,fundswilloftengrantaninterestinprofitsknownasaca rr iedinteresttoitsgeneralpartner(GP)inordertoincentivizetheGPtomaximizeprofitsoverall.

Theformofcarriedinterestcanvarywidely,butgenerallywillfallintooneoftwostructures:first,itcanbeaccruedonadeal-by-dealbasis;or second,itcanbebasedontheperformanceoftheentirefund.Thisarticlediscusseshowclawbacksworkinthecontextofprivateequitycarriedinterestanddiscussessomewaystoavoidormanageclawbackliability.

HowDoClawbacksWork?Whenafundallowsforacarriedinterest,acommonprovisionintheagreementisforaclawbackfromtheGP.Inessence,iftheGPreceivesadistributionagainstitsaccruedcarriedinterestthatitendsupnotbeingentitledto

(oftenforfailingtomeetcertainperformancelevels),theGPmustreturnittothefundsothatitcanbeallocatedbacktothelimitedpartners(LPs).Effectively,itservesasadeficitrestorationobligation(DRO)fortheGPintheeventthatitsbookcapitalaccountisnegative.

Forexample,assumeafundcalculatesa20%carriedinterestbasedonoverallperformance.Inthefirstyear,thefundhasunrealizedgainsof100,andaccruesacarryof20totheGP.TheGPthentakesadistributionofthat20ascash.Inthesecondyear,thefundhasanunrealizedlossof100.Inceptiontodate,thefundhasnoprofit,andthustheGPisentitledtonocarriedinterest.HowevertheGPhasalreadytakenadistributionof20.Ifthefundliquidateswithnofurthergains,aclawbackprovisionprotectstherightsoftheLPstoreceivethatcashback.

TheDecisiontoIncorporateaClawbackThereisnorequirementforapartnershiptohaveaclawbackprovisioninitsagreement.Partnershipallocationsarehoweverrequiredtohavesubstantialeconomiceffect,andonecomponentofthatisa DRO,whichisarequiredobligationbyapartnerinapartnershipagreementtorestoreanydeficit(positiveornegative)balanceintheircapitalaccountwhenthepartnershipliquidates.ADROcanmirroraclawbackprovisionforaGPsinceanypartnerwithanegativebookcapitalaccountuponliquidationwouldberequiredtomakeacontributionatleastequaltothedeficit.ButevenaDROisnotnecessarilyrequiredifapartnershipmeetsanalternativetestforeconomiceffect,suchasaqualifiedincomeoffset.Ultimately,itisuptothefundmanagertodecidehowthefundshouldoperateandwhethertoincorporateaclawbackprovision.IfanLPinvestinginafundwishestoprotectitsinterest,itwouldeitherneedtoconfirmthataclawbackexistsintheagreement,orrequestitpriortosigning.

HowtoManageorAvoidaClawbackLiability

LimitsonDistr ibutions

Atitssimplest,afundcanavoidanypossibilityofaclawback(whetherrequiredbytheagreementorpurelyfromaninvestorrelationsstandpoint)bymakingnodistributionstotheGPuntilitisabsolutelycertaintheGPisentitledtoacarry.Thisisperhapseasiestinadeal-by-dealstructure,wheretheeconomicsofaparticulardeal,andthusthecarriedinterestcalculation,arecertainatitscompletion.Similarly,ahedgefundcalculatingacarriedinterestonaquarterlybasisshouldbeabletodeterminethecarryatthecloseofeachperiod.Butwhereacarryisbasedontheoverallperformanceofthefundsinceinception,itmaynotbepossibletobecertainhowmuchcarriedinteresttheGPisentitledtountilliquidation.

Thissimplecasehowever,isunlikely.EveniftheGPwishestoavoidtakingdistributionsofcarriedinterestuntilthecalculationiscertain,itwillstilllikelyreceiveongoingallocationsoftaxableincomebasedontheaccruedbookcarry.TaxallocationstotheGPcannotsimplybemadeuponliquidationwhenthecarryisdeterminedanddistributedsincetheremaynotbeenoughtaxableincomeduringtheyeartoallocateforthecarryinfull.TheGPwilllikelyreceiveallocationsasincomeisrecognized,meaningthattheGPwilllikelywanttaxdistributions,ifnothingelse.Taxdistributionsarenotapartfromthecarriedinterest;theyare,infact,debitedfromtheGP’scapitalaccount,andreduceanyfuturecarriedinterestdistributions.IftheGPisultimatelyentitledtolesscarrythanthetaxdistributionsitreceivedinceptiontodate,andiftheagreementcontainsaclawbackprovision,theGPwouldberequiredtopaybackitstaxdistributionswhetherornot itreceivesataxbenefitforlossesallocatedinlateryears.

Ba lanceCompeting Interests

Sincethereisnorequirementforaclawbackprovision,fundshaveflexibilitytowritetheminwaysthatbalancethecompetinginterestsoftheGPandLPs.WhileLPsmayinsistonaclawback,theGPmaybeabletonegotiateacapontheamount,suchasaclawbackonlyfordistributionsinexcessoftheGP’staxliability.TheGPshouldalsoplanforsomeamountofliquidity,eitheritselforfromitsmembers,justincasethereisaclawback.Ifamanagerfeelsthatoneormorememberswouldbeunabletorecontributeaclawbackobligationtothefund,itmaywishtorequirethatcashisputinescrow,orsimplynotdistributedoutoftheGPuntilaparticularevent.

FundCapita liza tion

TheGPcanalsoavoidormitigateaclawbackthroughafundcapitalization,whichgenerallyoccursnearorafterthetermofthefund.Whileafundiswindingdown,theGPmaydecidetocontinuetomanageitsremaininginvestmentswhichcanbeaccomplishedbycreatinganewfund.Theremainingassetsoftheexistingfundwillbesoldorcontributedtothenewfundalongwithnewbuyercapital.Investorsoftheexistingfundmayhavetheoptiontoselltheirinterestorrollitoverintothenewfundeitheronexistingfundtermsornewfundterms.Newinvestorscan:1)purchaseinterestfromexistinginvestorswhochoosetosellor2)committoadditionalcapitalforadd-onornewinvestments.Meanwhile,theGPgenerallywillberequiredtorolloveritsinterestintheexistingfundtothenewfund.

ThefundcapitalizationdescribedaboveallowsforagreatertimeperiodfortheGPtoearncarryandpotentiallyreduceoreliminatetheclawbackliability.Theclawbackrelatedtotheinvestorsthatcashedoutfromtheexistingfundwillhavesettledwiththenewinvestorcapital.Investorsthatchoosetorolloverintothenewfundmaybewillingtore-setthevaluationoverwhichcarriedinterestdistributionsarepayable,factoringinanyclawbackamount.Fromataxperspective,underthisscenariothereisnotaxgainorlosstoreportattheGPlevel.TheGP’staxbasisintheexistingfundwillbecarriedovertothenewfund,whichshouldbeclosetoitsequityinvestment.TheGPwouldhavereceivedtaxincomeallocationsclosetocarriedinterestdistributioninyear(s)distributedcausinglittletonochangeinbasis.Itisimportanttonotethatafundrecapitalizationoffersmultiplepotentialupsideswithclawbackflexibilitymerelybeingoneofthem.

Timing

Anotherconsiderationisthetimingoftheclawbackliability.Generally,theclawbackliabilityisappliedonceatorneartheendofthefund’stermwhenthereisnoadditionalcarriedinterestexpected.Fortheirownbenefit,however,LPsaremorelikelytorequestinterimclawbacktestdatesfromtheinvestmentperiodthroughtheendofthefundterm.Periodictestingcanhelpmitigateclawbackobligations.Iftestingshowstheremaybeanobligation,thefundcanpreventfuturedistributionstotheGP.Additionally,thefundshouldmaketheclawbackcalculationifthereareonlystragglerinvestmentssincetherewouldbenoadditionalcarriedinterestatthatpoint.Theseinvestmentscoulddelaytheliquidationofthefundorevencausethefundtoextendtheterm,whichcouldcausetensionamongsttheLPs.

TheTakeawayThehandlingoftheclawbackprovision,orlackthereof,andhowtheobligationispaidcanbeasourceofconflictbetweentheLPsandtheGP.Toeasethistension,itisimportantwhenafundiscreatedtodiscussclawbackobligationdetailsandforthepartnershipagreementtoincludeproperprovisions,ifapplicable,thatmeetboththeLPsandGPs’expectations.

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TaxReformImpactsonHobby-RelatedDeductions

OneprovisionoftheTaxCutsandJobsActof2017(TCJA)thathasreceivedmuchattentionisthesuspensionofmiscellaneousitemizeddeductionssubjecttothe2%ofadjustedgrossincomelimitationfortaxyearsbeginningin2018.However,whathasnotgarneredmuchattentionisthatthisprovisioncouldcreatehighlyadversetaxconsequencesfortaxpayerswithincome-generatinghobbies.

Undergeneraltaxprincipals,taxpayerswhoareengagedinatradeorbusinessmaydeducttheirordinaryandnecessary

businessexpenseswhencomputingtheirtaxableincome.Ifthereareexcessexpenses,thisnetlosscan,atleasttoa

certainextent,offsetothernon-businessincome.However,thelawdoesnotallowtaxpayerstotreattheirhobbiesas

businessesinordertogetthetaxbenefitofexpensesrelatingtothosehobbies.Infact,underthenewlaw,NONEofa

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taxpayer’shobbyexpensesaredeductible.Asageneralrule,thelawfrownsuponactivitiesthatarenotengagedinforprofit

—andtherearerulesIRSusestotrytofindandtaxthoseenterprises.Considerthefollowingfactpatterns:

Taxpayer1hasafarmandraiseshorses.Shelovestorideandapproachesherenterpriseasahobby. Shehasroomtoletafewpeopleboardtheirhorsesinherbarnforafeeandshehasfieldsthatsheallowsotherstomowforhaywhichshesells.Thissmallincometypicallyaround$42,000peryear helpsoffsethercosts.Thisincometypicallytotals$2,000peryear.Becausehercostsinoperatingthefarmaresohigh,shehasneverpaidattentiontoreportingtheincome.

Taxpayer2isindependentlywealthy.Herentssomeretailspaceintownandoperatesabookstoreasasoleproprietorship.Helovesbooks,lovesinteractingwithpeoplewholiketoreadandenjoyscomingtoworkeveryday.Thoughhesellssomebookshisincomenevercoversallthecostsanditneverwill—buthedoesn’tcare.Hereportstheincomeandexpensesonhistaxreturn,showingasmalllossthatsheltersotherincome.

Finally,Taxpayer3and4shareapassionforoldfurniturethattheyfind,refurbishandsell.Theirfriendsappreciatetheirfinecraftsmanshipandoftenaskfortheirhelpwithcertainpieces.Theybothhavejobsandreadilyacknowledgethatthebusinessisfirstandforemostforfun.Sincetheyareconservativewithrespecttotaxmatterstheyhavealwaysroughlylimitedtheirexpensedeductionstotheirincomefromthebusiness.Lastyear,theysold$20,000offurniturethattheypurchasedfor$1,000.However,theircoststorepairandrefurbishthepieceswere$22,000.Theyonlydeducted$19,000,showingnonetincomeandnoloss.

Before2018,alloftheabovetaxpayerscoulddeducttheirexpensesuptotheamountoftheirhobbyincomeandtotheextentthoseexpensesexceeded2%oftheiradjustedgrossincome.Thesedeductionshelpedminimizeanytaxthatneededtobepaidassociatedwiththeincome.UndertheTCJA,theseexpensesarenolongerdeductible.Instead,theynowhavetoreporttheirincomeandareallowedNOdeductionfortheirexpenses.Intheaboveexamples,nowTaxpayer1mustreportandpaytaxonher$2,000ofincome,Taxpayer2mustreportallhisbookincome(althoughhecanhecandeductanycostofbuyingthebookshesells),andTaxpayers3and4mustreport$19,000ofincomeandcandeductnoneoftheirexpenses.

TheTakeawayItisnotuncommonfortaxpayerstooperateenterprisesthatforeverlosemoney.IfthoseenterprisesaredeemedbyIRStobehobbies,thentheresultsdescribedabovewillhappentothesetaxpayersWhilethereareguidelinespublishedbyIRSfordeterminingwhetherataxpayerisrunningahobbyorabusiness,thereisoftenmuchgrayarea.Taxpayerswhohaveapotentialforthisriskshouldconsultwiththeirtaxadvisorsaboutthenatureoftheirriskandwhatcanbedonetomanageormitigatethatriskgoingforward.

  

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ExportTaxIncentives:IC-DISC,FDIIorBoth?

PriortotheenactmentoftheTaxCutandJobsAct(TCJA),theInterest-ChargeDomesticInternationalSalesCorporation(IC-DISC)wastheonlyremainingexporttaxincentiveaftertherepealoftheforeignsalescorporationandextraterritorialincomerules.TheTCJAintroducedanewexporttaxincentive,theForeign-DerivedIntangibleIncome(FDII)deduction.

Whetherataxpayercanorshouldutilizeoneorbothoftheexporttaxincentivesisacomplicatedandhighlyfact-specificanalysis.Thisarticleprovidesanoverviewoftheexporttaxincentives,eligibilityrequirementsandtheoverlapbetweenthetwo.

IC-DISCOverview

AnIC-DISCisadomesticCcorporationthathasmadeanelectiontobetaxedasanIC-DISC,subjecttoeasilymanagedadministrativerules.IC-DISCsarenotsubjecttofederalincometaxonqualifyingexportincome.Qualifiedexportincomeisincomederivedfromthesaleofqualifiedexportproperty(definedbelow).Instead,theIC-DISC’sshareholdersaresubjecttotaxwhendividendsarepaidordeemedpaidtothem.Iftheshareholdersareultimatelyindividuals,trustsortrustbeneficiaries(i.e.,notaCcorporation),thencorporateleveltaxmaybeavoidedaltogether,andthetaxableincomewouldconsistsolelyofdividendspaidtothoseshareholdersorbeneficiaries.

ForCcorporationshareholders,thisdividendincome(anddoublelayeroftax)canbedeferredbyissuingproducerloansorfactoringforeigntradereceivables.Factoringreceivablesistheprocessofpurchasingaccountreceivablesatadiscountedpriceandlatercollectingthefullamountofthereceivablesataprofit.Inaddition,ifcloselyheld,aCcorporationthatpaysdividendstoitsshareholderscanclaimafederaltaxdeductionforaportionofthosedividendsintheformofacommissiondeductionwhenutilizinganIC-DISCownedbythosesameshareholders.

AcommissionIC-DISCprovidessalesandexportrelatedservicestoarelatedpartysupplierandispaidacommissionforthoseservices.Thecommissionisthehigherof4%ofqualifiedexportgrossreceipts(definedbelow)or50%onthenetincomefromthesaleofexportproperty.Therelatedsuppliercanalsoclaimataxdeductionforthecommissionpaid.Abuy/sellIC-DISCpurchasesexportpropertyforresaleoutsidetheU.S.,resultingin100%ofthenetincomequalifyingforbenefits.

Exportpropertyisqualifiedpropertythatismanufactured,produced,grownorextractedintheU.S.,andisheldintheordinarycourseofbusinessforuse,consumptionanddispositionoutsideoftheU.S.Qualifiedexportreceiptsinclude,butarenotlimitedto,grossreceiptsfrom:

Thesale,exchange,orotherdispositionofexport property;Thelease,licenseorrentalofexportpropertyusedoutsidetheU.S.(includingsoftware);Servicesrelatedtothequalifiedsale,exchange,lease,rental,ordispositionofexportproperty;andEngineeringorarchitecturalservicesforconstructionprojectsoutsidetheU.S.

FDIIOverviewTheFDIIrulesallowCcorporationsadeductionof37.5%ofitsFDII(reducedto21.87%fortaxyearsbeginningafterDec.31,2025)resultinginatopfederaleffectivetaxrate(ETR)of13.125%oneligibleincome(16.41%fortaxyearsbeginningafterDec.31,2025).TheFDIIdeductionfollowsaformulaapproachtodetermineanannualdeemedtangiblereturnequalto10%oftheinvestmentindepreciablefixedassets(QBAI).Theexcessofdeductioneligibleincome(DEI)overthisdeemedtangiblereturnisconsidereddeemedintangibleincome(DII).TheforeignderivedportionofDEIorincomeearnedfromforeignuseoractivityisFDDEI.Theformulaisasfollows:

DEI=GrossincomewithcertainmodificationsFDDEI=DEIderivedfromforeignuseoractivityDII=ExcessofDEIover10%returnonQBAIFDII=(FDDEI/DEI)xDII

Inaddition,thesaleofpropertyforforeignusetonon-U.S.personslocatedoutsidetheU.S.,includingthelease,license,exchange,orotherdispositionoftangibleorintangibleproperty,qualifiesasFDDEI.TheincomefromthefollowingcategoriesofservicesprovidedorusedoutsidetheU.S.areFDDEI:

PropertyServices–locationofproperty

ProximateServices–locationofbusinessoremployeesTransportationServices–originanddestination(50%foreignifU.S.iseitherone)GeneralServices–recipientlocation

ToqualifyforFDIIbenefits,taxpayersmustfollowstrictandcomplicatedrulestodocumenttheforeignuseoractivity.PropertysalestoanunrelatedU.S.personortoaforeignpersonforfurthermanufactureintheU.S.donotqualify.Inaddition,servicesprovidedwithrespecttopropertyorpersonslocatedintheU.S.donotqualify.

Transactionswithforeignrelatedpartieshavespecialrules.Propertysalescannotqualifyunlesstheproductisresoldto,orusedinorincorporatedinaproduct,whichisresoldtoaforeignunrelatedpartyandthetaxpayerestablishestothesatisfactionoftheSecretarythatit’sforforeignuse.Further,salestoaforeignrelatedpartyofotherthanpurchasedpropertydonotqualify,unlessthesellerreasonablyexpectsmorethan80%ofrevenueearnedbytherelatedpartyfromuseofthepropertyfromtheunrelatedpartytransactionqualifiesforbenefits.

Generalservicesprovidedtoaforeignrelatedparty,whoisabusinessrecipient,qualifyifnotsubstantiallysimilartoservicesprovidedbytherelatedpartytopersonsintheU.S.AsubstantiallysimilarserviceisdefinedasoneusedbyaforeignrelatedpartytoprovideservicesbytheforeignrelatedpartytoapersonintheU.S.,andeitherabenefitsorpricetestismet.Thebenefittestismetif60%ormoreofthebenefitsprovidedbytheserviceweretopersonslocatedintheU.S.Abenefitmeanstoprovideareasonablyidentifiedincrementofeconomicorcommercialvaluetoacustomerandnotanindirectorremotebenefit.Thepricetestismetif60%ormoreofthepricepaidbyapersonlocatedintheU.S.totheforeignrelatedpartywasattributabletotheU.S.servicesrenderedtotheforeignrelatedparty.

FDIIorIC-DISC?TheFDIIdeductionresultscurrentlyinanETRof13.125%onexportincomeandthenincreasesto16.41%after2025.IftherelatedsupplierisaCcorporation,acommissionIC-DISCusingthe50%ofnetincomemethodresultsina10.5%ETRontheexportincomeafterdeductingthecommission.Abuy/sellIC-DISCresultsinnocorporateleveltax.Whenexportrelateddividendsarepaidtoindividualshareholdersfromeither,theypaythequalifyingdividendrate.

FDIIdocumentationrequirementsforforeignuseoractivityaremorestringenttomeetandmaybehardertoobtainfromcustomers.Asaresult,moretransactionsmayqualifyforIC-DISCbenefitsthantheFDIIdeduction.However,FDIIappliestoabroaderrangeofservicesthantheIC-DISC,whichislimitedtoservicesrelatedtothesaleorleaseofpropertyandengineeringandarchitecturalservicesforprojectslocatedoutsidetheU.S.

WhenacommissionIC-DISCisusedandtransactionsqualifyforbothFDIIandIC-DISCbenefits,ataxpayermayclaimbothonthesametransaction.However,formulaadjustmentsareneededincalculatingtheallowabledeductionunderboth,astheIC-DISCcommissionreducestheFDDEIandtheFDIIdeductionreducestheIC-DISCcommission.Althoughtheresultisareduceddeductionundereachcalculationseparately,thecombineddeductionmaybegreater.

TheTakeawayClearlythisisacomplicatedandhighlyfact-specificanalysisandgreatcaremustbegivenindeterminingwhichprovidesabettertaxbenefit.However,ifacloselyheldCcorporationdeterminesitiseligiblefortheFDIIbenefits,

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Legal."AndersenGlobaldoesnotprovideanyservicesandhasnoresponsibilityforanyactionsofthememberfirms,andthememberfirmshavenoresponsibilityforanyactionsofAndersenGlobal.Nowarrantyorrepresentation,expressorimplied,ismadebyAndersenTax,nordoesAndersenTaxacceptanyliabilitywithrespecttotheinformationanddatasetforthherein.Distribution

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thentheIC-DISCshouldbeaconsiderationaswell.CompaniescurrentlyutilizinganIC-DISCshouldconsideriftheycanbenefitfromtheFDIIdeduction.