An interest charge domestic international sales corporation (“IC-DISC”) is a special tax exempted domestic corporation that qualifies under Sections 991 through 994. The IC-DISC incentivizes (from a federal income tax perspective) exporting U.S. manufactured property. An IC-DISC is not the operating exporter but rather is a separate entity that receives a tax-free commission from the operating entity in an amount limited by the Code. This tax-free commission can produce valuable tax savings and deferral of income for qualifying exporters.

Pursuant to Section 992(a)(1), the statutory requirements of an IC-DISC, in addition to being a domestic corporation, are (a) 95% or more of its gross receipts consist of qualified export receipts, (b) the adjusted basis of the qualified export assets at the close of the taxable year are at least 95% of the sum of the adjusted basis of all assets of the corporation at the close of the year, (c) the corporation does not have more than one class of stock, and the par or stated value of its outstanding stock is at least $2,500 on each day of the taxable year, and (d) the corporation makes an election to be an IC-DISC by filing Form 4876-A.

Generally, qualified export receipts under Section 993 are sales, leases, or certain services related to export property, meaning property (i) manufactured in the U.S., and (ii) sold for direct use outside the U.S., where (iii) less than 50% of the export property’s sales price is attributable to imported materials. When a business qualifies, the operating exporter can pay the IC-DISC a sales commission for each sale as if the IC-DISC were an inside salesperson. Pursuant to Section 994(a), this commission is capped at the greatest of (a) 4% of the operating company’s gross receipts from qualifying exports, (b) 50% of the operating company’s net income from qualified exports, or (c) taxable income based on the sales price actually charged (but subject to transfer pricing rules under Section 482). The sales commission received by the IC-DISC is exempt from taxation at the IC-DISC level. However, dividends paid by the IC-DISC to its owners are generally subject to capital gains taxes as qualified dividends. Additionally, the IC-DISC must keep books and records separate from the operating company’s books and use the same tax year as the majority shareholder of the IC-DISC.

When used correctly by an eligible exporter, an IC-DISC can provide two important tax benefits. First, particularly where the operating entity is a pass-through entity (such as an S corporation or a partnership), an IC-DISC creates tax rate arbitrage by reducing the tax rate for a portion of the operating entity’s income via the tax-exempt sales commission payments made to the IC-DISC, which are deductible to the operating entity. In addition, IC-DISCs trigger income only when they make distributions to their shareholders. As a result, there can be tax deferral where the owners elect not to pay dividends. Finally, because IC-DISCs are exempt only from federal income taxes, it may be advisable to form the corporation in a state that does not impose corporate taxes.

John G. Hodnette is an attorney with Johnson, Allison & Hord in Charlotte.

August 31, 2022/by TAX