If you produce your crops in the United States and export some or all of your harvest, you may wish to consider using an interest charge domestic international sales corporation (IC-DISC) to reduce your federal tax burden. Once established, you can realize a lower effective federal tax rate on all subsequent sales. As such, it’s best to evaluate this opportunity before the harvest.
How does it work?
An IC-DISC is a separate corporate entity that earns a “commission” from the operating company’s export sales based on the greater of 1) 50% of net income on sales of qualified exports or 2) 4% of gross receipts from qualified export sales. The operating company receives a deduction from its reported income for the commission paid at ordinary tax rates on its federal return. A properly executed IC-DISC does not pay federal taxes.
The IC-DISC distributes all of its profits as qualified dividends, and the owners pay tax on the dividends at capital gains tax rates. Depending on the owners’ personal income levels, federal capital gains tax rates could be as low as 0% or as high as 23.8% (the highest federal capital gains rate of 20% plus 3.8% of net investment income tax).
How much federal tax can it save?
To illustrate, let’s suppose Family Farms, Inc. (a fictional S corporation) earns $120,000 in net income from export sales and pays $60,000 in commissions to its IC-DISC. Assuming the owners qualify for the highest capital gains tax rate of 23.8%, they’ll owe federal tax of $14,280 on qualified distributions from the IC-DISC.
The owners also owe less tax on their S corporation earnings. Family Farms, Inc. can deduct $60,000 in commissions paid to the IC-DISC, resulting in a tax savings of $23,760, assuming that the owners are in the highest federal tax bracket of 39.6%.
The net savings is $9,480 ($23,760 – $14,280), or 15.8% of the commission charge.
What steps are required?
As noted earlier, the benefits of an IC-DISC only come into play once the new corporate entity has been established. The operating company cannot pay commission to the IC-DISC for any sales that were completed before it came into being. That’s why it’s important to contact your tax advisor and “run the numbers” before the harvest.
If a financial assessment proves favorable for an IC-DISC – i.e., the benefits outweigh the costs of setting up and administering the IC-DISC – then the following steps should be pursued:
- Form the new IC-DISC entity under state law.
- Make the IC-DISC election within 90 days of formation.
- Offer only one class of stock with par or stated value of stock of at least $2,500.
- Maintain a separate set of books and records for the IC-DISC.
One final note: the IC-DISC is among the last of the available export incentives. That being said, there is no guarantee that it will remain in effect indefinitely. Nonetheless, the savings across one or more years may still make the effort worthwhile.
If you have any questions or would like any assistance in analyzing your potential benefits from an IC-DISC please contact us at IC-DISC@aldrichadvisors.com, or 503-620-4489.