Tuesday, June 21, 2011

Tax Break for Exporters

We are taking a look at an Interest Charge – Domestic International Sales Corporation (IC-DISC).

As you can guess, this has to do with a company which exports. I remember the DISC as providing a tax deferral, but it has another tax feature that we like as much or more.

Here is quick breakdown of how the IC-DISC would work:

(1) There is an exporting company (ExCo)

(2) ExCo (or its owners) set up a second company (DISC) and elect to be treated as an IC-DISC.

(3) ExCo pays DISC a commission

(4) DISC pays no tax on the commission (up to a point) as long as 95% of its activities and assets are export-related.

NOTE: Do you see what is happening? DISC pays no tax on the commission. ExCo deducts the commission and reduces its tax.

(5) DISC may pay dividends to its shareholders.

(6) If DISC does not pay dividends, there will a charge to the shareholders. The charge will vary depending on whether the shareholders are individuals or a corporation. Individuals will pay interest (hence “Interest Charge – DISC”). There is a different tax treatment for corporations.

The DISC can be a “paper” company. That is, it does not have to perform any substantial economic functions. It does not have to have employees or office space, for example. Pretty much the only thing it has to do is keep its own books and records, which an accounting department can do. You incorporate, print some new stationary and continue doing what you were doing before. How much easier can this be?

There are of course limits on how to calculate the commission; otherwise you would have a product selling for $50 with a thousand dollar commission tacked onto it. The commission is 4% of the qualified export receipts or 50% of ExCo’s taxable income, whichever is greater.

The DISC can defer $10 million in commissions EVERY year. There is even a way to increase this limit.

The tax deferral is sweet, but Rick and I like the dividend treatment as much or more. We expect the DISC to be an S corporation, and its shareholders to be the same as those for ExCo. We can also see a wealth transfer opportunity here by having the younger generation as the owners of the DISC, while mom and dad (or grandmom and granddad) still own ExCo. We are thinking of having the DISC distribute every year. Under this scenario there is no deferral. We want to move money out of the main company (ExCo), which would otherwise be taxed at the maximum rate, and push it to DISC, whose dividends are taxable at 15 percent. This would be an immediate 20% tax savings.

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