Obama’s Impact on the Last Tax Incentive for Exporters

The current administration’s proposed policies are generally perceived as negative by most businesses that transact globally. This coming at a time when most U.S. manufacturers are finding it harder and harder to compete with manufacturers around the world. However, there may still be some good news for closely held businesses that sell domestically manufactured goods overseas. Dating back to 1971, lawmakers in Washington have had a history of providing tax breaks to U.S. companies that export U.S. made products and even certain services. Due to complaints mainly coming from the European Union claiming we were providing unfair illegal export subsidies, these incentives have come and gone throughout the years. Only one little known tax incentive which has been part of the tax code for the last 37 years remains – the IC-DISC. An IC-DISC, or Interest Charge-Domestic International Sales Corporation, can offer exporters a substantial amount of permanent tax savings. This “paper only” entity allows its shareholders to pay tax on export income at the 15% corporate dividend tax rate rather than at the 35% ordinary income tax rate. Here’s a quick summary of how an IC-DISC structure works. A U.S. company that has qualified exports sets up a domestic shell company (the IC-DISC) which acts as a commission agent for the U.S. company’s export sales. Once the IC-DISC is set up, the U.S. company can pay commissions to the IC-DISC. According to the tax code, these commissions can be as high as 50% of net export income or 4% of gross export receipts, whichever is higher. The benefits are as follows: • The commission is fully deductible at ordinary income tax rates (generally 35%). • The IC-DISC is a tax exempt entity and therefore pays no federal income tax. • The IC-DISC is allowed to distribute its income to its owners (usually the same owners as the export company) as a qualified dividend taxed at 15%. The result is a permanent reduction in taxes of 20 cents on every commission dollar representing the difference between the commission deduction at top ordinary tax rates and the income at qualified dividend rates. Some say that this benefit may diminish somewhat after 2010 when the 15% qualified dividend rate enacted in 2003 is slated to expire and increase to 20% under the Obama budget. However, the Obama proposed budget also raises the top ordinary income rate to 39.6 % keeping the tax arbitrage benefit for those in the highest brackets basically the same. A cost benefit evaluation reveals that an IC-DISC generally makes sense for companies with $1 million or more in revenue from qualified exports. Qualified export goods must have at least 50% of its fair market value come from U.S. sources. Export revenue from manufactured goods, architectural/engineering services, entertainment products and software all qualify. Furthermore, the IC-DISC is actually much broader than people tend to realize. For example, if a manufacturer sells its product to another U.S. company, which in turn exports that product, the manufacturer can still qualify to treat those sales as export revenue in certain circumstances. While most likely you will need the assistance of a tax professional to help you establish an IC-DISC, it can pay for itself literally in a matter of months. Setting up the structure only takes a couple of weeks and the compliance costs are relatively reasonable, but those who can utilize this extremely powerful benefit should act soon. Unlike many tax incentives which may be captured by amending prior years tax returns, IC-DISC benefits are only available for transactions occurring after the IC-DISC is set up. Michael M. Tonthat is a CPA tax partner at Hedman Partners in Santa Clarita. He can be reached at [email protected] or at (661) 310-2188.