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IC DISC:Interest Charge Domestic

International Sales Corporation

John Denisonjdenison@cbh.com

January 19, 2012

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Basics of IC-DISC and Taxes Saved

• IC-DISC starts as Domestic C-Corp

• Its purpose is to assist the exporter with their export sales, and the DISC is entitled to commission equal to the greater of

• 50% of the export profits or

• 4% of export sales (limited to profits)

• Exporter deducts commission at up to 35% Fed Tax

• DISC pays no Federal income tax on Commission income

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Basics of IC-DISC and Tax Savings (cont.)

• Shareholders of IC-DISC are not taxed until dividends are distributed

• Individual shareholders are taxed at qualified Dividend rate of 15%

• IC-DISC History goes back to 1971, but in 1986 FSC became much more popular, as it was a permanent tax benefit, and the DISC was conceived as deferral only.

• Deferral: Commissions of up to $10 mio of export sales every year can accumulate in the IC-DISC and do not need to be paid out as dividends – thus originally the IC-DISC was meant as a deferral benefit, but since 2004 the 15% dividend rate is more advantageous

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Calculation Example – Tax Benefits C-CorporationQualified Export receipts 5,000,000

Cost of Goods Sold (4,000,000) Gross Margin 1,000,000

Selling, General & Admin. Expenses Apportioned (500,000)

Combined Taxable Income 500,000

Commision CalculationGreater of:1) The Lesser of:

(a) 4% of gross receipts, or 200,000 (b) 2 times the amt. Computed under CTI 500,000

Lesser of (a) or (b): 1) 200,000

2) 50% of Combined Taxable Income 2) 250,000

Greater of 1 or 2 = Commission to IC-DISC 250,000

3) Tax Savings: Diff 35% Corp. rate 35% 87,500 Assuming C-corp paying dividends, thus 15% Div rate irrelevant

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Who May Be a Good Candidate

• Manufacturers, Distributors, assembler, agriculture producer, software maker, extractor, engineering/architectural services provider

• Benefit where exports are at least $2 m at decent profits (10% or better) = $200,000 min export profit = 100k commission = min 20k tax savings

• Exporters often do not realize how much they export, since much of it (or even all of it) may be indirect through others

• Should be closely held enterprise, but can also be public company

• Savings min 20% of ½ of export profit (see above) for flow-through entity, as much as 35% for dividend paying C-Corp

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IC-DISC and Qualified Export Property

• Independent of Sec 199 Domestic Production Activities Deduction – Can take both IC-DISC and Sec 199 benefits

• Possible to “Piggy back” DPAD project – improve DPAD

Qualified Export Property leading to Qualified Export Receipts: • Manufactured, produced, grown, extracted in US by person other

than IC-DISC• Held for sale, lease or rental for direct consumption/disposition

outside the US (incl. indirect sales)• Services related and subsidiary to qualified sale, rental etc• Architectural & Engineering Services for construction projects

outside US

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What Qualifies as Export Property

Export Property• Made, grown extracted etc in US by person other than DISC• Held for sale, lease or rent for use, consumption, disposition outside US• No more than 50% of FMV of product sold attributable to articles imported in the US• Not sold or leased to another IC-DISC in the same controlled group

NOT Export Property• Patents, trademarks, models, inventions, designs, processes, copyrights, goodwill• Prohibited products per 1979 Export Administration Act• Unprocessed timber which is softwood• Depletable property like oil, gas, coal or uranium• Presidentially decreed property in short supply

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IC-DISC Benefits – Entity Types

• Exporter Flow-through (S-Corp or Partnership/LLC)• Assuming owners are taxed at 35%, the IC-DISC can turn ordinary income into

Dividend Income at 15% = 20% savings

• IC-DISC owned by individual SHs or Flow-through entity

• Consider IRA or Roth IRA ownership as well

• Exporter Private C-Corp • C-Corp taxed at 35% max, generally can only pay out add. comp to reduce corp

tax, and esp. in cases of many SHs C-Corp may pay div already. Thus IC-DISC saves 35% corp tax–Div % same

• IC-DISC should be owned by Exp. SHs – No benefit if owned by exporter C-Corp (since no beneficial 15% rate)

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IC-DISC Benefits – Entity Types

What IC-DISC benefits for Public Company exporter?

• Exporter C-Corp (US public company)• C-Corp taxed at 35% max, generally pays dividends.

• Public company usually widely held, thus not practical for IC-DISC to be owned by SHs -> US public entity best to utilize IC-DISC as a non-qualified compensation plan for executives

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Qualified Export Assets – 95% test

• IC-DISC Receivables like commission receivable• Temporary Investments• Producer loans (loaned commission back to exporter)• Stock or securities of related Foreign Export Corp (FISC)• PEFCO Securities• Funds awaiting investment

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Non-Tax Reasons for IC-DISC

Why use an IC-DISC (in addition to the obvious tax benefits)?

• Sale of a company or other succession

• Use DISC to finance the deal – had one client who was officer of co. purchasing C-Corp stock and was advised to just pay out bonuses, but why not use IC-DISC benefits?

• Executive Bonus plan

• Could use deferral or just straight out rate differential for particular person or group of executives as bonus plan

• Estate planning

• Consider gift tax implications under Rev.Rul. 81-54

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IC-DISC Commission Details

1. Identify qualified export receipts – don’t forget indirect sales

2. Track COGS for each export receipt (if possible)

3. Track SG&A:1. Direct export expenses – allocable to exports 100%

2. Indirect export expenses – apportioned based on appropriate methods

4. Identify and eliminate loss transactions

5. Perform full costing and marginal costing calculations

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IC-DISC Implementation Timeline

• NO BENFITS PRIOR TO IC-DISC INCORPORATION

• File SS-4 and incorporate

• File Form 4873-A within 90 days of incorporation

• Decide on owners:• With C-Corp Exporter, usually C-Corp owners

• With S-Corp/LLC/other Exporter, usually entity

• Can also be IRA – very careful here

• Prepare IC-DISC documents, by-laws, articles of incorp., minutes, stock certificates, export sales agreement

• Set up general ledger for IC-DISC and bank account

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Questions