The two year tax cut bill enacted in December, PL 111-312, extended the 15% tax rate on qualified dividends. This also extended the benefits of IC-DISC (or DISC). Using a DISC, exporters of goods made in the U.S. get a subsidy of at least 10% of their profits on those exports. If your business sells $1 million or more of U.S. made goods for use outside the U.S., you need a DISC. You can get benefits regardless of whether your business makes or just distributes the goods. The benefit applies for partnerships, corporations, and even sole proprietors.
This is good news for all exporters, who can continue to get an export subsidy. The 15% dividend tax rate and regular tax deduction (often at a 35% tax rate) of the DISC commissions combine to reduce Federal income taxes. This export subsidy is at least 10% of export profits. The subsidy also applies to engineering and architectural services for non-U.S. construction projects, but not to most other services. To get this export subsidy, you must have a separate paper company that elects DISC status. It must be in place before the goods are sold or the construction services are billed.
DISC is NOT cutting edge, aggressive, or risky. It has been around since 1971, but was of limited use from 1984 to 2003, when the tax rate on dividends changed. Congress affirmed during the Bush administration that they wanted to keep DISC and the benefits for mid market exporters.
Several things are required for your business to get this subsidy. There must be a separate U.S. corporation that has filed an IRS election to be treated as a DISC. It is purely a paper corporation with $2,500 of capital and no other substance. This corporation must have agreements with the business operating entities to get a commission. The commission is calculated under complex IRS rules based on export sales or net profits on those sales. The business gets a Federal income tax deduction for this commission. The DISC does not pay tax on its income. The DISC can defer some profits, but must distribute the rest. The ultimate shareholders pay tax at the 15% rate rather than regular Federal income tax rates on the distributed commission. This results in up to a 20% Federal tax rate differential.
Simple example: Smitty’s Plumbing Supply sells $3 million of pipe fittings made in Ohio to customers in Windsor, Ontario. Smitty’s net profit margin is 8% overall, so it made $240,000 on the sales to Ontario. Smitty, the owner, is in the 35% tax bracket. Without a DISC, Smitty would pay $84,000 of Federal income tax on the export profits. If Smitty owned a DISC, he could reduce that tax by at least $24,000.
Calculating the commission in its simplest form can be done on a Post-It ™ note, but the result likely will not be optimum. Several techniques can increase the benefit. These include application of the “no loss” rule, the overall profit percentage, or “marginal costing.” These techniques increase the complexity and cost of making the calculation, but for enough sales volumes can be very worthwhile. Optimizing these calculations in a way the IRS will approve requires experience. For very large transaction volumes, specialized software may be required. For many mid-market companies, these additional costs are trivial in comparison to the additional tax savings from DISC optimization. Consider each year to whether optimization calculations are worthwhile.
If you’re an exporter of U.S. made goods, DISC can probably help you, but you need help to set up a DISC and calculate the best benefit. A new corporation is needed, since the DISC election must be made at the start of the DISC’s tax year. Also, the DISC and the business entity must have the appropriate agreements in place, and the DISC should have an “evergreen” dividend resolution. Missing a key piece can kill your benefit.
Remember, savings from DISC start only when the new DISC is in place. Act now to start getting these tax benefits by calling Steve Fox.