Today’s mantra is “Survival of the Fittest.” U.S. manufacturers are tightening their belts amid international competition, which is breathing down their necks. The current economic climate is forcing companies across the country to cut costs, cut production, and cut jobs. Many manufacturers, once vibrant and growing, are closing their doors for good.
But many are surviving. In fact, some U.S. manufacturers are even thriving. The reason? These forward-thinking companies are taking advantage of tax incentives which were created to help them survive.
Many small- and middle-market companies are not aware they qualify for tax breaks. In order to survive in the current economic climate, U.S. companies must educate themselves on the tax incentives available to them. Congress has a history of providing tax breaks to U.S. manufacturers for such activities as research & development, domestic production, hiring workers, and utilizing alternative fuels.
These various incentives have come and gone throughout the years, incentivizing a wide array of business activities; but for exporters, there really is only one, albeit a tremendously powerful, option. This tax strategy can increase your after-tax margin on exports by 10 percent.
This incentive is called the Interest Charge - Domestic International Sales Corporation (IC-DISC). The IC-DISC traces its heritage as far back as 1971, but until 2003, it did little more than provide a tax deferral opportunity. This benefit was well appreciated by the Fortune 1000, but it packed little punch for the small and middle-market. In 2003, the tide turned.
Today, the IC-DISC regime allows U.S. companies to set up separate domestic entities which act as commission agents for the company’s export sales. Once the IC-DISC is set up, the U.S. company can pay commissions to the IC-DISC. These commissions can be as high as 50 percent of net export income or 4 percent of gross export receipts, whichever is higher.
Why the IC-DISC is So Powerful
But why is it a good idea to pay a commission to the IC-DISC? There are three reasons: First, the commission is fully deductible. Second, the IC-DISC pays no federal income tax. Third, the IC-DISC is, at heart, a Subchapter C Corporation, meaning it distributes its income to its owners as a qualified dividend. The result is a permanent reduction in tax of twenty cents on every commission dollar (taking the difference between the top ordinary income rate and the qualified dividend rate).
Companies often dismiss the IC-DISC as inapplicable to their business, but the IC-DISC is actually much broader than most people realize. It covers the sale of products that are manufactured in the United States, but that doesn’t even mean the taxpayer must be the manufacturer.
In the same vein, if a manufacturer sells its product to another U.S. company, which in turn exports that product, then the original manufacturer can qualify just the same. Moreover, it is not only the export of tangible goods which qualifies; the provision of architectural and engineering services is incentivized by the IC-DISC as well. So if an engineering firm designs and builds a building in China, that engineering service would qualify for IC-DISC treatment.
Like Many of the More Powerful Tax-cutting Tools, It Must Be Handled With Care
On the surface, the rules governing the IC-DISC seem manageable; however, in order to maximize the benefit available to a company utilizing / implementing an IC-DISC, a firm that specializes in this complex structure needs to be engaged to manage the DISC structure on a monthly or quarterly basis. Implementing the IC-DISC, while offering extremely powerful benefits to companies, is littered with minefields and traps for the unwary that can cause businesses to miss out entirely on the benefits or claim much less than they actually deserve.
This is Not a Loophole
There has been speculation that the benefits available through the IC-DISC may be short-lived. Many look for the Obama Administration to eliminate the ability to take IC-DISC dividends as qualified dividends. However, the White House seems to be singing a different tune, according to Dean Zerbe, who spent seven years as Tax Counsel on the Senate Finance Committee.
Zerbe notes that while there are many “loophole closers” present in the proposed budget released by the White House, the same budget “is loud in its silence on [the IC-DISC].” He goes on to explain: “The White House can read the tea leaves that a proposal to eliminate IC-DISC would be a political loser and would meet very real bipartisan opposition in the Senate.”
Others point to the imminent change in the ordinary income and qualified dividend tax rates, and particularly the spread between the two, on which IC-DISC benefits depend. The current rates are set to expire on December 31, 2010. Once again, Zerbe points to the Obama budget proposal, which would set qualified dividends at 20 percent, while raising the top ordinary income rate to 39.6 percent. Says Zerbe, the “IC-DISC will remain in place for the foreseeable future.”
That is good news for U.S. exporters, who face a struggling domestic economy and formidable international competition. But the clock is ticking. Unlike many incentives which may be captured on old returns, IC-DISC benefits are only available for transactions occurring after the IC-DISC is set up. Companies must be proactive in all areas of their business. Those that aren’t may not survive.
alliantgroup, LP is a provider of specialty tax services that works with CPA firms and their clients. For more information, visit www.alliantgroup.com