IC-DISC Update for VALET Membersexportvirginia.org/.../IC-DISC-Webinar-2014.10.16.pdf · 10/16/2014...

IC-DISC Update for VALET Members

Bill Major, CPA Partner – International Tax October 16, 2014

Learning Objectives

1) Explain what an IC-DISC is. 2) The IC-DISC tax benefit is tied to the differential between qualified dividend rates and the ordinary income tax rates. Please explain. 3) What types of businesses are eligible to take advantage of these tax savings? i.e. LLCs, LPs, C Corporations? 4) What tax savings can a company expect from having an IC-DISC? 5) When should a company form an IC-DISC?

Learning Objectives

6) Does the exporter have to hire an outside company or can their accountant do the IC-DISC? 7) Are there tax saving opportunities other than IC-DISCs for exporting companies? 8) What qualifications must companies meet to take advantage of the tax savings? 9) What can the Qualified Export Receipts include? 10) What is included in the Qualified Export Assets?

Learning Objectives

11) What are the steps in setting up an IC-DISC? 12) Please comment about situations where it does NOT make sense to form an IC-DISC. 13) Does the possibility of tax reform affect IC-DISC?

14) Any other questions you may have.

1) Explain what an IC-DISC is.

How does a company and its owners save federal tax with an IC-DISC?

IC-DISC Myth IC-DISC Reality

“IC-DISCs are tax shelters. If I use an IC-DISC, it means an automatic audit, right?”

• Tax regulations formerly exempted IC-DISCs from being considered tax shelters.

• In practice, companies export first, then use IC-DISCs. They don’t form an IC-DISC and then start exporting.


• The IC-DISC is a “paper” company that has limited substance. Customers do not need to know that the operating company has an IC-DISC.

• IC-DISCs do not require office space,

employees, or tangible assets. • Any company or individual – domestic

or foreign – can be a shareholder of an IC-DISC.

Operating Company IC-DISC

Owners

IC-DISC

Operating Company

Owners

2) The IC-DISC tax benefit is tied to the differential between qualified dividend rates and the ordinary

income tax rates. Please explain.


• The Operating Company deals directly with customers, just as it always has.

• The maximum amount of the tax-

deductible commission is set by tax law and is determined with reference to the taxable income derived from the Operating Company’s export transactions.

• IC-DISCs do not pay federal tax. • Dividends from IC-DISCs to

individuals qualify for tax rates that are lower than rates that apply to ordinary income.


Owners

IC-DISC

Owners

Operating Company

Deduction against high-taxed income

Low-Taxed Dividend Income



Customers

Customers


• The commission expense reduces income taxed at higher, ordinary rates

• IC-DISC pays no federal tax

• The dividends paid by the IC-DISC to individuals, S Corps, trusts or estates are taxed at lower capital gain rates.


Owners

IC-DISC

Owners

Operating Company





Customers

Customers

3) What types of businesses are eligible to take advantage of these tax savings? i.e. LLCs, LPs, C Corporations?

Does it matter how my business is organized for tax purposes?

There is a potentially applicable IC-DISC structure for any business that has qualifying export sales:

• Domestic LLCs, S Corporations or partnerships

• Domestic C corporations

• U.S. or foreign individuals

• U.S. or foreign trusts (not taxed as associations)

• Foreign LLCs or partnerships

• Foreign corporations

• The IC-DISC is a “paper” company that has limited substance. Customers do not need to know that the operating company has an IC-DISC.

• IC-DISCs do not require office

space, employees, or tangible assets.

• Any company or individual –

domestic or foreign – can be a shareholder of an IC-DISC.


Owners

IC-DISC

Owners

Operating Company


IC-DISC Myth Response

“The $10 million limitation means larger companies aren’t allowed to have IC-DISCs.”

• The $10 million limitation applies

only to how much income an IC-DISC can accumulate and its shareholders can defer from taxation.

• There is no limit on how much the IC-DISC can earn and distribute right back out to its shareholders as dividends.



“Foreign-owned companies cannot have IC-DISCs.”

• Granted, there are technical tax

issues involving U.S. and foreign tax laws and how they interact with treaties.

• Out-of-the-box thinking about global structures often yields interesting alternatives that sidestep these technicalities.



“Our bankers won’t allow us to have an IC-DISC because they don’t want to see more cash leaving the company.”

• When you look at the entire

picture, it often turns out that less cash will leave the company because the overall tax of the company and its owners will be reduced.

• Any IC-DISC structure can be tweaked to ensure that dividends from an IC-DISC have to be put back into the Operating Company.


4) What tax savings can a company expect from having an IC-DISC?

Example Calculation of Permanent Tax Savings Export Sales 2,000,000 Less: Cost of Goods Sold – Export Sales ( 1,000,000) Gross Margin 1,000,000 Less: Related SG&A Expenses ( 500,000) Export Net Income 500,000 IC-DISC commission (greater of): 50% of export net income (50% of $500,000) 250,000 4% of export sales (4% of $2,000,000) 80,000 IC-DISC commission expense deducted from ordinary income 250,000 Federal tax savings 39.6% 99,000 IC-DISC corporate-level tax Federal Exempt IC-DISC dividend 250,000 Federal tax cost (20% + 3.8%) ( 59,500) Net permanent federal tax savings = Reduction of tax on ordinary income 99,000 Federal tax on dividend income (59,500) = 39,500

5) When should a company form an IC-DISC?

When does it make sense to form and operate an IC-DISC?

When the tax permanently saved exceeds: • the relatively small cash cost to form, implement and

maintain, plus

• the soft cost of taking away resources devoted to other things

When does it make sense to form and operate an IC-DISC?

Rule of Thumb:

$200,000 in annual pre-tax net income from export sales

6) Does the exporter have to hire an outside company or can their accountant do the IC-DISC?

7) Are there tax saving opportunities other than IC-DISCs for exporting

companies?

• Three tax topics often go hand in hand for companies operating in the Technology, Life Sciences, Manufacturing and Distribution sectors

IC-DISC – DMD – R&D Credit If your company is claiming the benefits of any one of these incentives, why isn’t your company claiming the benefits associated with the other two incentives?

Tax Savings Other Than IC-DISC?

8) What qualifications must companies meet to take advantage of

the tax savings?

Qualifications

IC-DISC

Owners

Operating Company

Deductions against high-taxed income


Customers All of the tax law qualifications

pertain solely to the IC-DISC, not to the exporter forming the IC-DISC:

• 95% of receipts test (Question 9) • 95% of assets test (Question 10) • Must be a C corporation formed

under State or DC law • Must be capitalized for $2,500 • Must have only one class of stock • Must make timely election

9) What can the Qualified Export Receipts include?

95% of the IC-DISC’s own total receipts throughout the course of the IC-DISC’s entire year

must consist of Qualified Export Receipts

Qualified Export Receipts Include

• Commissions earned by the IC-DISC that are based on the Operating Company’s profits from permitted activities that qualify for IC-DISC benefits.

• Interest Income on IC-DISC Working

Capital • Interest Income on Producer’s Loans

made by the IC-DISC to Exporters

IC-DISC

Owners

Operating Company

Deductions against high-taxed income


Customers

What activities qualify for IC-DISC benefits?

Manufacturers Qualify!

One of three tests: • Substantial Transformation

• Substantial operations and activity is considered

manufacturing or production within the meaning of the relevant industry

• 20% Conversion Cost Safe Harbor

• Substantial Contribution


"Our products are merely a component of a larger product made outside the U.S. and sometimes that product is imported back to the U.S. We don't qualify."

Products that are shipped outside of the U.S. that are component parts of another product can qualify even if the component returns to the U.S. for products to be used or consumed in the U.S. Suppliers to the auto industry.


Some U.S. Components Qualify!


"We are a manufacturing company, but we do not export our products. Our customers or distributors are the ones who export. We don't qualify."

Manufacturers who sell to U.S. companies that ultimately export the products may qualify – e.g., manufacturer of chemical products that are ultimately exported by their customer/distributor.

Indirect Exporting Qualifies!



"Our company is a distributor and we do not manufacture any products. We don't qualify."

Distribution of U.S. made goods that are eventually consumed or used outside the U.S. qualifies for IC-DISC benefits.


Distributors Qualify!


"We are a software company and export incentives do not apply to us. We don't qualify.”

Software that is downloaded from a server in the US by a Company outside the US or software licensed for reproduction outside the U.S. may qualify.


Software can Qualify!


"We perform our engineering services in the U.S. relating to construction projects. We don't qualify."

Engineering and architectural services performed inside or outside the U.S. qualify if they are in connection with an actual or proposed foreign production or construction project.


Engineers and Architects can Qualify!


"We merely lease the product for eventual use outside the U.S. We don’t qualify."

• U.S.-manufactured goods/products that are leased for use outside the U.S. by a third party can qualify.

• The goods/products can be new, used or refurbished.

Equipment Leasing Qualifies!



"We don't manufacture. We grow or extract our product. We don't qualify."

• Crops grown or certain minerals extracted in the U.S. and exported may qualify.

• Cannot claim IC-DISC where percentage depletion is taken.


Agriculture or Certain Mining Qualifies!

• State tax return apportionment data. • “Ship to” state is identified as foreign. • “Lots” of sales to the states of Florida or Texas going specifically to

Miami or Laredo.

• Do you have sales to foreign customers? • Canada and Mexico are considered foreign countries, despite NAFTA. • Foreign customers includes related parties and subsidiaries. • Does your product get distributed by others to foreign locations? • Is your product made, produced, grown or extracted in the U.S.?

• Do foreign parties license software from you?

• Do you provide services to foreign customers?

• Construction projects occurring outside the U.S. • Related to products made in the U.S. but used outside the U.S.


10) What is included in Qualified Export Assets?

95% of the IC-DISC’s total assets

as of the end of the IC-DISC’s year must consist of Qualified Export Assets

Qualified Export Assets

• Necessary working capital • Commissions Receivable that are

• Paid off within 60 days after the IC-DISC’s year-end • Based on a reasonable estimate that was recognized by

the IC-DISC’s year-end.

Qualified Export Assets

• Producer’s Loans • Accumulated IC-DISC Income • Growth in Inventory plus Net Fixed Assets – plus R&D

expenses for year • Cumulative Inventory plus Net Fixed Assets plus R&D

expenses

• Private Export Funding Corporation commercial paper.

• Foreign International Sales Corporation stock.

11) What are the steps in setting up an IC-DISC?


“Using an IC-DISC takes too much work. All our accounting systems have to be changed. Customers are going to question why they are suddenly dealing with a new company."

• The most work an IC-DISC will ever

likely take is during its first year. • The IC-DISC’s only customer is usually

the existing operating company. • Invoices that customers will receive will

continue to come from the operating company and look no different just because there’s an IC-DISC in the background.

• Customers will make payments to the operating company in the same manner as before.

How much work is it to have an IC-DISC?

How much work is it to have an IC-DISC? (First Year)

• Decide on ownership • Form a corporation under State (or D.C.) law.

• One class of shares • Capitalize for $2,500 minimum

• 90 days from incorporation: Submit IRS Form 4876-A to elect IC-DISC status

• Year-end

• Conduct annual meeting • Decide on form & timing of dividend • Make adjusting journal entries on IC-DISC’s and Operating Company’s

books

• After year-end • Finalize computations of export income and IC-DISC commission • Prepare and submit IC-DISC tax return

How much work is it to have an IC-DISC? (Following Years)

• Decide on ownership • Form a corporation under State law.

• One class of shares • Capitalize for $2,500 minimum

• 90 days from incorporation: Submit IRS Form 4876-A to elect IC-DISC status

• Year-end

• Conduct annual meeting • Decide on form & timing of dividend • Make adjusting journal entries on IC-DISC’s and Operating Company’s

books

• After year-end • Finalize computations of export income and IC-DISC commission • Prepare and submit IC-DISC tax return

What do I have to do now to qualify for IC-DISC benefits?

Decide on structure

Form a new corporation under State law, obtain

FEIN

Capitalize corporation

minimum $2,500.

Submit IRS Form 4876A To elect IC-DISC status

Limit = 90 days

Adopt agreements relating to

commissions, shareholders, etc.

Annual Board

Meeting

Exporters pay

Commission to IC-DISC?

IC-DISC distributes

dividends to shareholders?

Year End of IC-DISC

Exporters pay remaining

Commission to IC-DISC

Limit = 60 days

IC-DISC distributes remaining

dividends to shareholders

Submit 1120

IC-DISC tax return

Limit = 8 ½

months

1 3 5 8

4 6 7 9

10

11 2

12) Please comment about situations where it does NOT make sense to form

an IC-DISC.

IC-DISCs change the amount of tax on income without changing the amount of income being taxed.

Therefore, IC-DISCs don’t make sense when:

• Net (pre-tax) income from exports is under $200,000

per year • Income is already being taxed at a low effective rate.

• The ultimate taxpayer has no taxable income.

13) What does the prospect of tax reform mean for IC-DISC?


“Aren’t IC-DISCs going away at the end of 2014?”

No, IC-DISCs aren’t going away. • Consider the history of the repeated

expiration and extension of the R&D credit. • The qualified dividend rate has already

survived for two extensions. • The last effort to repeal IC-DISCs altogether in

2007 died pretty quickly. • The S Corp Association, the National

Association of Manufacturers, and the Club for Growth are all behind export tax incentives.

What does the prospect of tax reform mean to IC-DISCs?


“The WTO made us get rid of DISCs, then FSCs, then the extraterritorial income exclusion. The WTO is going to make us get rid of the IC-DISC, too.”

The WTO is on record stating the interest-charge feature of the IC-DISC prevents the deferral from taxation from being an illegal export subsidy.

What does the prospect of tax reform mean to IC-DISCs?

Contact Information

Bill Major, CPA Partner, International Tax Services [email protected] Cherry Bekaert LLP 1075 Peachtree St NE Suite 2200 Atlanta, GA 30309 (404) 209-0954

IC-DISC Update for VALET Membersexportvirginia.org/.../IC-DISC-Webinar-2014.10.16.pdf · 10/16/2014...

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