IC DISC: Interest Charge Domestic International Sales Corporation John Denison jdenison@cbh.com January 19, 2012

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

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

Calculation Example – Tax Benefits C-Corporation

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

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

What Qualifies as 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

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)

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

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

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

IC-DISC Commission Details Identify qualified export receipts – don’t forget indirect sales Track COGS for each export receipt (if possible) Track SG&A: Direct export expenses – allocable to exports 100% Indirect export expenses – apportioned based on appropriate methods Identify and eliminate loss transactions Perform full costing and marginal costing calculations

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

Questions