The implementation of IC-DISCs saves growers, food manufacturers, and other exporters of U.S. goods and services millions of dollars in federal income tax each year. By way of example, a California exporter with $1,000,000 in taxable income from qualified export sales, could save more than $95,000 each year in federal income tax. What follows is a brief discussion of IC-DISCs and the tax benefits they present.
Due to the significant federal income tax savings potential, we have advised many clients in evaluating and implementing IC-DISCs. In light of the prominence of California's agriculture and food exports, not surprisingly, many of our clients to implement IC-DISCs have been growers and food manufacturers.
How Do IC-DISCs Work and What Are the Tax Savings?
Most commonly, the IC-DISC is treated as the U.S. exporter's broker for export sales. As such, the exporter pays the IC-DISC a commission, which the exporter may deduct as a business expense so long as certain rules are followed. Among those rules is the requirement that the commission be determined using one of three statutorily authorized methods. Of these methods, often the most tax-favorable and practical method is the one which requires commissions to be set at 50% of the taxable income derived from export sales (plus 10% of marketing expenses attributable to those sales).
While the exporter receives a deduction for the commissions paid, the IC-DISC pays no federal income tax on the commissions received. In fact, putting aside certain exceptions, commissions (or other income) of the IC-DISC are not taxed until distributed to the IC-DISC shareholders. Further, such distributions are treated as qualified dividends currently taxed at a maximum federal rate of 20%.1
1 A more comprehensive discussion of the taxation of IC-DISCs and their shareholders would include the rules relating to the "interest-charge" imposed on IC-DISC shareholders with respect to undistributed IC-DISC income, and deemed distributions which arise in the event an IC-DISC has taxable income attributable to exports in excess of
$10,000,000. While these, and other issues not discussed here should be thoroughly considered with tax counsel, since the interest-charge, which is based on one-year Treasury bill rate, remains low, and the fact most IC-DISCs do not generate taxable income in excess of $10,000,000, these issues are not addressed in detail here.