Export incentives: here's a money-saver that's never been targeted by the WTO.
However, there is one export incentive that remains intact and is now more attractive than ever due to the lowered rate of tax on dividends created by the Jobs and Growth Tax Relief Reconciliation Act of 2003. It's called the Interest Charge--Domestic International Sales Corporation or IC-DISC, and it has survived the repeals of U.S. export incentives since 1984 and has never been targeted by the WTO.
Deriving tax benefits through an IC-DISC is slightly more complicated than the EIE because the latter simply required the completion of IRS Form 8873 to calculate the exclusion. By contrast, an IC-DISC is a separate, domestic corporation requiring a minimum of $2,500 in capitalization. The new corporation must formally elect to be treated as an IC-DISC and is required to maintain a separate bank account and set of accounting books. The IC-DISC must also file an annual U.S. income tax return even though it pays no U.S. income taxes.
The basic operation of an IC-DISC works like this:
* A U.S. exporter (or other shareholders) forms an IC-DISC corporation.
* The U.S. exporter pays an annual, tax-deductible commission on its export sales to the IC-DISC (the commission deduction could yield a tax benefit as high as 35 percent).
* The allowable commission rate is either 50 percent of export net income or 4 percent of gross export income, whichever is greater.
* The IC-DISC pays no U.S. income tax on the commission income.
* The commission income is accumulated and untaxed in the IC-DISC.
* The IC-DISC shareholders are required to pay interest (to the IRS) on the accumulated but untaxed income.
* The IC-DISC shareholders pay U.S. income tax on dividends received from the IC-DISC when distributions are made (the tax on dividends for individuals is now 15 percent).
* This deferral of income is allowable on annual export sales up to $10 million.
An important feature is that the IC-DISC shareholders can be the related exporter, the exporter's shareholders, the exporter's management employees or family members. The exporter, therefore, has the flexibility to create liquidity for its shareholders, create management incentives and facilitate succession planning. On the other hand, the IC-DISC may lend the accumulated funds back to the exporting company in exchange for a note plus interest, rather than distributing the funds to its shareholders. This approach mitigates the exporter's cash drain created by the commission payments until such time as the IC-DISC makes distributions.
The permanent tax savings for U.S. exporters and their shareholders can now be a high as 20 percent. That is, the commissions paid to the IC-DISC create 35 percent tax benefits for the U.S. exporting corporation while the individual shareholders of the IC-DISC would pay only 15 percent U.S. income tax on dividends received. All owner-managed or closely held exporters should move quickly to investigate this opportunity in order maximize tax savings.
Richard D. Shapland is director of International Tax Services at Virchow Krause & Co. in Bingham Farms, a member of the Detroit Regional Chamber.
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|Title Annotation:||World Trade Organization; Extraterritorial Income Exclusion|
|Author:||Shapland, Richard D.|
|Date:||Jul 1, 2005|
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