Guest Blogger: Dr. Allison Evans, associate professor of accounting, Cameron School of Business
U.S. exporters can potentially generate large tax savings - roughly 20 percent of their original tax bill - by forming an IC-DISC (Interest-Charge Domestic International Sales Corporation). The most common type of IC-DISC acts, at least on paper, as the exporter’s sales agent. Yet, while the IC-DISC does have recordkeeping and capital requirements, it does not need to have a physical location, employ a single person or interact with any customers. In essence, it can be invisible to those who do business with the exporter, but yield a substantial reduction in the exporter’s tax bill.
Is this type of strategy a tax shelter? According to regulations issued by the U.S. Treasury Department, it is not. Congress originally created this type of entity in the tax law to help U.S. exporters, and the Treasury Department and courts continue to uphold it as a valid, legal tax-planning option.
The IC-DISC is a powerful tax subsidy because it takes advantage of a rate differential embedded in the tax laws. Once formed, an exporter essentially uses it to convert approximately half of its ordinary business income (taxed at higher statutory rates) into dividend income for its underlying owners (taxed at lower, preferential rates). The resulting tax savings can be significant.
Though manufacturers may first come to mind as exporters, many other types of businesses can qualify, as well. Distributors of domestic products qualify, for example, as do manufacturers whose product is part of an exported good (such as car tires or seats). Other examples include: engineering or architectural service firms who consult on foreign projects; software developers; companies that rent or lease exported property; companies that provide warranty or repair services related to export property; and agricultural cooperatives.
As focus increases on U.S. import and export policies, it is important for exporters and the public to know about this existing tax subsidy. The IC-DISC strategy works best for businesses with a small number of owners. While this constraint does eliminate many exporters from the potential pool of users, there are numerous exporters that could qualify to use it but do not. Users of another tax subsidy for companies who sell products made or grown in the U.S. - the Domestic Production Activities Deduction – can use the IC-DISC strategy, as well.
Any company interested in exploring the option of creating an IC-DISC should do so with the help of a tax professional. Several public accounting firms have teams that specialize in this area.