I recently wrote a post on the benefits that IC-DISC provide to companies who export. In this supplement, I will explain the actual steps involved and the additional incentive that may allow you to defer 100% of the tax. These are the details you will need to know if you plan on taking advantage of this opportunity.
How IC-DISC Works
In order for you to pay less tax, you need to be able to re-characterize ordinary income to capital gain income. That’s how the IC-DISC process became part of the tax code. This process replaces the ordinary income tax rate (up to 39.6%) with the capital gain rate (20%) by simply re-characterizing the income you receive.
While operating an IC-DISC can be very technical, it can be simplified into five steps for the perspective taxpayer.
1.Export your product
2.Generate income on exported products
3.Calculate a “commission” on the earned income. The calculation is governed by statute.
4.Pay the commission to a separate IC-DISC corporation’s bank account
5.The IC-DISC corporation pays a “dividend” back to the business in an amount equal to the commission income received.
The dividends are treated as qualified dividends which are taxed at capital gain rates, not ordinary income rates, so you’re essentially just re-characterizing your income.
If you are in the highest tax bracket (39.6%) and use an IC-DISC, you would only pay capital gains tax (20%) resulting in a savings of 19.6% on those earnings. So, if your commission is $1 million, you could save $196,000, depending on your tax rate.
Defer 100% of Tax
There is an additional incentive above saving the maximum of 19.6% which allows you to defer 100% of the tax for a maximum of five years. Step 4 above changes in that instead of paying back the money as a dividend it is paid as a “producer loan.” During these five years, you can strategically plan your tax payments while only paying an extremely small interest charge on the deferred amount.
There are tests you must meet to qualify for this benefit. Just because you qualify for the traditional IC-DISC does not guarantee that you will meet the requirements for this additional incentive.
This is a very complex tax incentive. From the entity set-up to the compliance records, there are many rules and timelines to follow in order to have a successful filing.
Reach out to our firm if you think this could benefit you and your company—we’d be happy to walk you through the process.
By David Olson, CPA
Manager at WHH