OSCPA IC-DISC Presentation - Global Tax Consulting | Tax

Report
THE OHIO SOCIETY OF CPAs
CLEVELAND ACCOUNTING SHOW
TAX SAVINGS FOR CLOSELY HELD
MANUFACTURERS AND DISTRIBUTORS
George Elias, CPA
Global Tax Consulting, LLC
Office:330-225-7034
Cell: 216-577-0916
george.elias@globaltaxllc.com
1

An increasing number of closely held companies are using the often
overlooked IC-DISC (Interest Charge Domestic International Sales
Corporation) provisions of the Internal Revenue Code intended to help
U.S. companies compete internationally.

Many, however, are still not utilizing this federal government incentive, or
not capturing all of the available, intended and allowable benefits.

The AICPA, OSCPA, and the federal government itself are facilitating and
encouraging taxpayers to explore and take advantage of the IC-DISC.
george.elias@globaltaxllc.com
2






DISC - (Domestic International Sales Corporation) 1971-1984
FSC - (Foreign Sales Corporation) 1985-2000
ETI - (Extraterritorial Income Exclusion) 2000-2006
IC-DISC - (Interest Charge Domestic International Sales Corporation)
1984 to Present
The DISC, FSC, and ETI were all phased out due to opposition from
our trade partners such as the GATT, EU, and WTO over the years
(concluding with the phase out of the ETI in 2006).
The IC-DISC has not only survived, but has become more powerful
due to the “qualified dividend” rates of the 2001 Bush tax cuts.
george.elias@globaltaxllc.com
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
Tax incentive created by Congress to encourage exports.

Originally created to provide a deferral mechanism, in 2001 the ICDISC began to provide a permanent tax savings via the qualified
dividend rate (currently 15% maximum) to closely held exporters.
This was due to the Bush tax cuts.

At least 50% of Taxable Income, or 4% of Gross Receipts (limited to
taxable income) from products made in and used outside the U.S
are taxed at a 15% dividend tax rate instead of the 35% top tier
ordinary income tax rate.
george.elias@globaltaxllc.com
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
Requires setup of a corporation which elects treatment as an IC-DISC by
filing Federal Form 4876-A within 90 days of setting up a corporation.

Requires creation of specific inter-company agreements between the ICDISC and the IC-DISC owners.

Requires computation of the IC-DISC Commission (Multiple methods to
compute the DISC commission).

Annual filing of a 1120-IC-DISC tax return. Return due 9/15 each year. No
extension required.

No change in business operations needed. Transparent to customers.

Requires journal entries and movement of cash between entities.
george.elias@globaltaxllc.com
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Individual Owner(s)
Taxed at Ordinary Rates,
Typically 35%
US Operating Company
IC-DISC Commission
Deduction
Dividend, 15%
Tax rate
IC-DISC
Tax Exempt Entity
george.elias@globaltaxllc.com
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Without IC-DISC
Export Sales
Net Margin
Net Profit
5,000,000
5,000,000
20%
20%
1,000,000
1,000,000
IC-DISC Commission
(50% Method)
Taxable Income
Tax Rate
a) Corp. Level Taxation
Div. To Shareholder
Tax Rate
b) Shareholder Level
Taxation
c) Total taxation
(c=a+b)
With IC-DISC
Net Savings
500,000
1,000,000
500,000
35%
35%
350,000
175,000
0
500,000
15%
15%
0
75,0000
(75,000)
350,000
250,000
100,000
george.elias@globaltaxllc.com
175,000
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Individual Owner(s)
Dividend, 15%
Tax Rate
IC-DISC
Tax Exempt Entity
US Operating Company
Taxed at Ordinary Rates,
Typically 35%
IC-DISC Commission
Deduction
george.elias@globaltaxllc.com
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Without IC-DISC
Export Sales
Net Margin
Net Profit
5,000,000
5,000,000
20%
20%
1,000,000
1,000,000
IC-DISC Commission
(50% Method)
Taxable Income
With IC-DISC
Net Savings
500,000
1,000,000
500,000
35%
35%
a) Corp. Level Taxation
350,000
175,000
Div. To Shareholder
650,000
825,000
15%
15%
97,500
123,750
(26,250)
447,500
298,750
148,750
Tax Rate
Tax Rate
b) Shareholder Level
Taxation
c) Total taxation
(c=a+b)
george.elias@globaltaxllc.com
175,000
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
Goods ultimately used outside the U.S. (directly or Indirectly) that was
Manufactured, Produced, Extracted or Grown (MPEG) within the U.S.

Foreign Content Test – No more than 50% of foreign content allowed in
products (Foreign Content Costs/FMV = % of Foreign Content).

U.S. Manufactured Test – Safe harbor 20% of costs must be U.S. labor or
factory burden. Taxpayer does not have to be a manufacturer! Distributors
qualify.

Products must not be further manufactured within the U.S. by another party
before export. Further manufacture outside the U.S generally qualifies.

Certain services may qualify if intent is to build outside the U.S. Examples
include Architectural or Engineering Services.
george.elias@globaltaxllc.com
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Talk with a Specialist with knowledge of:

Qualification of IC-DISC Beneficiaries.

Identification of eligible activity (Sales).

Allocation and Apportionment of Expenses.

Transactional by Transactional (TxT) calculations.
george.elias@globaltaxllc.com
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Qualification of IC-DISC Beneficiaries:

Care must be taken to ensure proper initial set up of the IC-DISC
entity, required elections, preparation of shareholder agreements
between the IC-DISC and the related supplier, etc.

Basic maintenance of the entity, required estimates of the IC-DISC
commission, and preparation of all compliance documents (e.g. the
Form 1120 IC-DISC and Schedule Ps) are recurring activities.

Accounting Firm personnel with knowledge of the concept and
basic workings of the IC-DISC facilitate the process of utilizing the
incentive.
george.elias@globaltaxllc.com
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Identification of eligible activity (Sales):

IC-DISC eligible sales are often not traditional “export” sales. Customers
need not be foreign.

For example the following items have qualified for export incentives:
- Property sold to the U.S. Military used overseas.
- Transportation property used predominantly outside the U.S. (e.g. Jet
airplanes and certain parts sold to and flown by U.S. airlines).
- Components sold to U.S companies and initially shipped to a U.S.
location.
- Orbiting satellites used by NASA.
- Architectural plans for projects proposed for location outside the U.S.
- Equipment rental outside the U.S.
george.elias@globaltaxllc.com
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Allocation and Apportionment of Expenses:

Properly allocating expenses between domestic transactions and
IC-DISC eligible transactions and documenting those allocations are
permitted (similar to such an allocation made for Sec. 199
purposes).

Proper allocation of expenses often increases Net Income from ICDISC eligible transactions. For Example, salaries for Sales Managers
who only serve U.S. consumers do not have to be allocated to
international transactions.
george.elias@globaltaxllc.com
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Transactional by Transactional (TxT) calculations :

Calculating IC-DISC benefits at a transactional, rather than
aggregate, basis can add significant increases.

Sophisticated calculation engines can maximize tax savings by
dramatically increasing the IC-DISC benefit using the intended,
allowable, complex methods in the regulations. These engines also
generate the additional needed compliance.

Until 2006, public companies routinely enjoyed significant increases
in their export incentive calculations from detailed analyses using
calculation engines. Now, such increased benefits are available to
closely held companies through the IC-DISC.
george.elias@globaltaxllc.com
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Transactional Analysis:

Loss Exclusion – Loss transactions may be excluded, allowing benefit to be
derived from profitable transactions.

Marginal Costing – In conjunction with transactional analysis, marginal
costing is an element of the IC-DISC regulations which allows less
profitable transaction to derive IC-DISC benefit largely as if they were as
profitable as an average transaction.

Marginal costing can be applied at transactional, product, product line,
etc. levels. Highly sophisticated software is needed to optimize marginal
costing benefits in conjunction with loss optimization.
george.elias@globaltaxllc.com
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Transactional Analysis – Marginal Costing Example
Product
Group
Domestic
or Export
Sales
COGS
Expenses
Net
Income
Pens
Export
100
80
12
8
Pens
Domestic
100
75
5
20
200
155
17
28
Total
IC-DISC Commission Methods:
4% of Sales Method (100*.04) = $4
50% Net Income Method (8*.50) = $4
Marginal Costing Method (28/200 *100*.50) = $7
george.elias@globaltaxllc.com
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Benefit and Cost Summary:

Care must be taken to ensure proper initial set up of the IC-DISC entity,
required elections, preparation of shareholder agreements between the
IC-DISC and the related supplier, etc. Basic maintenance of the entity,
required estimates of the IC-DISC commission, and preparation of all
compliance documents (e.g. Form 1120-IC-DISC and Schedule Ps) are
recurring activities.

Companies only spend a few hours per year gathering easily obtainable
transactions from Sales and Cost systems.
george.elias@globaltaxllc.com
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Benefit and Cost Summary (Continued):

Fully optimized IC-DISC calculation is a great benefit to closely held
companies. Benefits far exceed basic calculation methods but require
specialized software to be optimized.

Costs of optimization calculations vary depending on volume and
complexity of the client and its business. Benefits are typically at least
five times the cost and are significantly greater.

Benefits can only be claimed on a go forward basis once a DISC is
established.
george.elias@globaltaxllc.com
19

The qualified dividend rate, which was recently extended with the Bush
era tax cuts through 2012, has created renewed interest in the IC-DISC.

Both political parties have indicated strong support of the qualified
dividend rate and encouraging exports.

Support from a bipartisan Senate consortium, IC-DISC benefactors, and
service providers lobbied successfully to have the DISC preserved as a
worthwhile incentive for U.S. production and exports of U.S. products.

As long as the spread remains between the qualified dividend tax rate and
ordinary income tax rates the DISC will be alive and well past 2012.
george.elias@globaltaxllc.com
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THANK YOU
George Elias, CPA
Global Tax Consulting, LLC
Office: 330-225-7034
Cell: 216-577-0916
Email: george.elias@globaltaxllc.com
george.elias@globaltaxllc.com
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