Exporters Rejoice! IC-DISC Is Given a Second Life
In an early draft of Senate Bill H.R. 1, the IC-DISC tax regime was repealed causing adverse tax implications to existing IC-DISCs, but the repeal has been completely left out of the final bill that was approved by the House and Senate conference committee on December 15.
The original bill was scheduled to impact taxpayers with tax years beginning after December 31, 2017. It revoked the IC-DISC election thereby forcing a deemed dividend out of accumulated income. The income was scheduled to be distributed to the IC-DISC owners over a ten year period, but the benefit that the owners would have received of the dividend being taxed at the capital gains rates rather than ordinary income tax rates was eliminated. Additionally, the income paid to the IC-DISC would have been taxed at corporate rates rather than being exempt from tax.
Fortunately, it appears as if the IC-DISC export incentive will remain for taxpayers when a Republican tax bill is ultimately passed….and what a better way to encourage domestic manufacturing and exporting!
Haven’t heard about IC-DISC?
It is one of the last great incentives available to companies who manufacture, produce, grow, or extract their products and export them overseas. (It is also available to a select group of other industries including architectural and engineering firms that are engaged in foreign projects.)
Two Main Tax Benefits of an IC-DISC
- It eliminates the corporate level of tax for corporate shareholders (it converts ordinary income into qualified dividend income for flow-through entities).
- It creates tax deferral on the profits related to the first 10 million dollars in export sales.
Take a simple example of a US toy manufacturer selling its products to Germany. If the manufacturer is a C corporation without an IC-DISC, it would be taxed once on the profits at the 35% corporate tax rate and then again at the 20% capital gains rates when the remaining earnings were dividend out to the individual shareholders. Every dollar in profit would be taxed twice resulting in an overall effective rate of 48%, leaving only 52 cents on the dollar. With the IC-DISC, commissions are paid from the C corporation to the IC-DISC where the initial layer of corporate tax at 35% would not be assessed on these funds. Dividends paid from the IC-DISC to the shareholders would be taxed at the 20% capital gain rate only, leaving 80 cents on the dollar. That’s a 28% effective tax savings! Additionally, profits related to $10 million in export sales can be deferred every year which can free up substantial cash flow to companies.
Looking ahead, we anticipate that Congress will reduce the corporate tax rate to 21% under the Tax Cuts and Jobs Act. So the initial layer of tax that the IC-DISC would eliminate at the corporate level would be 21% instead of 35%. The overall effective rate of savings is still a solid percentage of 16.8%. To come up with that figure, we compare a dollar without the IC-DISC taxed once at the proposed corporate tax rate of 21% and again at the 20% preferential capital gains rates, a result of 63.2 cents, versus a dollar with the IC-DISC taxed only once at the 20% capital gains rates, a result of 80 cents.
Flow-through entities currently pass their income to their individual shareholders where their profits are taxed at ordinary income tax rates up to 39.6% (not including the net investment income tax of 3.8%). Use of the IC-DISC with a flow-through entity would replace the 39.6% tax rate with the preferential 20% capital gains rates, or a savings of 19.6%. The proposed Republican legislation could effectively reduce the tax rate on a manufacturer’s flow-through income to 30% meaning that the IC-DISC would still save its owners 10% (the difference between 30% and 20%).
Regardless of Congress’ proposed new rate structure, the IC-DISC still presents itself as a substantial incentive to taxpayers in the manufacturing, architectural, and engineering industries.
Click here for additional information on IC-DISC.