FOR THE TAX-SAVVY EXPORTER: THE IC-DISC APPEARS TO BE STAYING WITH US

Congress has a history of providing tax breaks to U.S. companies that export U.S.-made products and even certain services. These incentives have come and gone throughout the years, but the IC-DISC remains, and it is powerful enough to increase after-tax margin on exports by ten percent.

There has been speculation that the benefits available through the IC-DISC may be short-lived. Many have thought that the Obama administration would eliminate the ability to take IC-DISC dividends as qualified dividends. The White House, however, appears to have other ideas. Dean Zerbe, national managing director of national tax consulting firm alliantgroup (Houston, TX), spent seven years as tax counsel on the Senate Finance Committee. He says, ?While there are many ?loophole closers? present in the budget released by the White House, the same budget is loud in its silence on the IC-DISC.?

Zerbe goes on to explain: ?The White House can read the tea leaves that a proposal to eliminate IC-DISC would be a political loser and would meet very real bipartisan opposition in the Senate.?

Others point to the imminent change in the ordinary income and qualified dividend tax rates, and particularly the spread between the two, on which IC-DISC benefits depend. The current rates are set to expire on December 31, 2010. Once again, Zerbe points to the Obama budget, which would set qualified dividends at 20 percent while raising the top ordinary income rate to 39.6 percent. Says Zerbe, the ?IC-DISC will remain in place for the foreseeable future.?

This is excellent news for U.S. exporters that face a struggling domestic economy and formidable international competition. But the clock is ticking. Unlike many incentives which may be captured on old returns, IC-DISC benefits are only available for transactions occurring after the IC-DISC is set up. ?Manufacturers must be proactive in all areas of their business,? explains Jim Young, alliantgroup?s export practice leader. ?U.S. manufacturers must educate themselves on the tax incentives available to them. For exporters, the IC-DISC is the only viable option left ? but it is a tremendously powerful one.?

The IC-DISC traces its heritage as far back as 1971, but until 2003 it did little more than provide a tax deferral opportunity. This benefit was well appreciated by the Fortune 1000, but it packed little punch for small and middle-market manufacturers. In 2003 the tide turned. Now the IC-DISC allows U.S. manufacturers to set up separate domestic entities which act as commission agents for the manufacturer?s export sales. Once the IC-DISC is set up, the U.S. manufacturer can pay commissions to the IC-DISC. These commissions can be as high as 50 percent of net export income or 4 percent of gross export receipts, whichever is higher!

There are three reasons why it is a good idea to pay a commission to the IC-DISC:

1. The commission is fully deductible.

2. The IC-DISC pays no federal income tax.
3. The IC-DISC is, at heart, a Subchapter C Corporation, meaning it distributes its income to its owners as a qualified dividend.

The result is a permanent reduction in tax of 20 cents on every commission dollar (taking the difference between the top ordinary income rate and the qualified dividend rate). Jim Young works with companies across the U.S. to increase profitability through this government-sponsored tax incentive. ?Often,? he says, ?manufacturers dismiss the IC-DISC as inapplicable, but many times they are wrong. The IC-DISC is actually much broader than most people realize. It covers the sale of products that are manufactured in the U.S., but that doesn?t mean the taxpayer must be the manufacturer.?

?In the same vein,? Young continues, ?if a manufacturer sells its product to another U.S. company, which in turn exports that product, the manufacturer can still qualify just the same. Moreover, it is not only the export of tangible goods which qualifies. The provision of architectural and engineering services is incentivized by the IC-DISC as well. So if an engineering firm designs and builds a building in China, that engineering service would qualify for the IC-DISC.?

On the surface, the rules governing the IC-DISC seem straightforward. But in order to maximize the benefit, however, a tax consulting firm that specializes in this complex structure should be engaged to manage the DISC structure on a monthly or quarterly basis. ?One manufacturer was claiming a $120,000 tax benefit via the IC-DISC structure that they implemented themselves,? says alliantgroup CEO Dhaval Jadav. ?When we reviewed their IC-DISC structure, we discovered that they should have been claiming $1.2 million in tax benefits, as opposed to the $120,000 benefit they had calculated themselves! This was a situation where the manufacturer and its CPA firm thought they understood the rules and thought they were maximizing the benefit of the IC-DISC structure. Unfortunately, nothing could have been further from the truth.?

The bottom line is this: the IC-DISC offers extremely powerful benefits to companies, but it is littered with minefields and traps for the unwary that can cause businesses to entirely miss out on the benefits or claim much less than they actually deserve. Approach it with care, but approach it for sure to improve your competitive advantage.

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alliantgroup, 3 Riverway, Houston, TX 77056, 713-350-3549, www.alliantgroup.com.