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IC-DISCs as a Tax Arbitrage and Wealth Transfer Strategy

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Moss Adams International Tax Partner Christine Ballard provides an in-depth look at the structures, benefits, and formalities for Domestic International Sales Corporations. (8/2016)

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IC-DISCs as a Tax Arbitrage and Wealth Transfer Strategy

  1. 1. 1 IC-DISCs as a Tax Arbitrage and Wealth Transfer Strategy By: Christine Ballard August 23, 2016
  2. 2. 2 WHAT IS AN IC-DISC?  Interest Charge Domestic International Sales Corporation (“IC-DISC”) oAllows IC-DISC shareholders to defer tax on export related income oNo federal taxation at the IC-DISC level oTaxes deferred until the income is distributed oIC-DISC shareholders are required to pay interest on the deferral of income
  3. 3. 3 WHY SHOULD YOU CARE?  IC-DISC reduces shareholder’s tax liability oOrdinary income is converted into qualified dividend taxed at preferential tax rates when distributed to IC-DISC shareholders  Exporting company can pay IC-DISC a tax deductible commission o The IC-DISC can distribute the commission to its shareholders in the form of qualified dividend o Exporting company must have taxable income  Tax rate reduction usually about 16%
  4. 4. 4 COMMON USED BY  US-based manufacturers and value added assembly operations  Distributors of US-manufactured products  Food and agriculture exporting nuts, apples, wine, etc.  Recyclers  US-based architects and civil engineers with foreign projects
  5. 5. 5 IC-DISC BASICS IC-DISC Shareholder Commission Flow of Funds Exporter IC-DISC (Tax Exempt) Dividend Tax deduction at ordinary rates 35% or 39.6% Tax Exempt * Watch States* Qualified Dividend 23.8%
  6. 6. 6 COMMON STRUCTURES Related Supplier IC-DISC Shareholder Shareholder Commission Qualified Dividend Example 1 - Passthrough Taxed at preferential rate to shareholders Deductible to supplier
  7. 7. 7 COMMON STRUCTURES IC-DISC Related Supplier (C Corporation) Shareholder Shareholder Commission Qualified Dividend Example 2 - Corporation
  8. 8. 8 USES IN FAMILY WEALTH TRANSFER  To recap – benefits for everyone o Tax rate arbitrage opportunity o Converts ordinary income to qualified dividend, taxed at capital gain rates  Uses in family wealth transfer o Ability to push income and cash to another generation o Set-up of an IC-DISC usually not considered a gift
  9. 9. 9 COMMON STRUCTURES LLC IC-DISC Shareholder (Patriarch) Heirs Commission Qualified Dividend Example 3 – Wealth Transfer Related Supplier
  10. 10. 10 WHO CAN BENEFIT?  Manufacturers, producers and resellers of “qualified export property”  Qualified export property include goods: oThat are produced in the US; oWith ultimate destination outside the US (sales to unrelated party); and oWhere the cost of foreign content does not exceed 50% of the sales price  IC-DISCs are widely used by owner-managed and family-owned businesses
  11. 11. 11 SETTING UP AN IC-DISC  IC-DISC must be set up as a separate entity o Incorporated as C corporation o Election has to be made to treat entity as IC-DISC (Form 4876) o Election must be filed within 90 days of the beginning of tax year in which the election will take effect o Single class of stock o Minimum capital $2,500 o Commission agreement between IC-DISC and exporter
  12. 12. 12 DETERMINING THE COMMISSION AMOUNT  Commission DISCs: Two primary methods may be used to determine the commission paid to IC-DISC o 4% of the “qualified export receipts” (simple method); o 50% of the combined taxable income of the related supplier & IC-DISC from the sale of qualified export property (i.e. foreign source income) o The former is generally used when related supplier is selling a high volume with low profit margins  Buy-Sell DISCs: Use Section 482 intercompany pricing methods. The DISC will have employees  Commission (or reasonable estimate) should be paid within 60 days after the close of tax year
  13. 13. 13 EXAMPLE – TAX SAVINGS IC-DISC Creates Tax Savings: Combined Almonds Walnuts Export sales gross receipts $105,000,000 50,000,000 55,000,000 Cost of goods sold (94,500,000) (45,000,000) (49,500,000) Gross margin 10,500,000 5,000,000 5,500,000 Selling, general and administrative expenses (7,350,000) (3,500,000) (3,850,000) Combined taxable income 3,150,000 1,500,000 1,650,000 % Foreign 90% 80% IC-DISC commission, greater of: 50% of export sales net income $ 1,335,000 $ 675,000 $ 660,000 4% of export sales gross receipts $ 3,560,000 1,800,000 1,760,000 IC-DISC commission (limited to taxable income) $ 2,670,000 $ 1,350,000 $ 1,320,000 Federal tax savings to exporter 39.60% 1,057,320 IC-DISC dividend $ 2,670,000 Federal tax on dividends paid by IC-DISC shareholder 23.80% (635,460) IC-DISC Federal net tax savings $ 421,860
  14. 14. 14 MAINTAINING IC-DISC STATUS  The IC-DISC must meet the following requirements annually o 95% or more of the gross receipts are “qualified export receipts” o The adjusted basis of the qualified export assets meets or exceeds 95% of the total adjusted basis of all assets held by the IC-DISC o The IC-DISC maintains only one class of stock o The par value of the stock is at least $2,500 for each day of the tax year o The IC-DISC maintains separate books and records o The election to be an IC-DISC is in effect for the tax year
  15. 15. 15 MAINTAINING IC-DISC STATUS  export assets under §993(b) include: oExport property oAssets used primarily in connection with the sale, lease, or other specified activities relating to qualified export property, and in connection with performing certain services oSufficient cash required to meet the working capital requirements oSubject to limitations, amounts on deposit in the US to acquire other qualified export assets
  16. 16. 16 CALIFORNIA CONSEQUENCES  FTB Ruling 2015-02  “Unwinds” IC-DISC transactions  IC-DISC files its own California return  IC-DISC pays only $800 minimum tax
  17. 17. 17 THANK YOU Christine Ballard CPA, MST Partner, National Tax International Tax Services MOSS ADAMS LLP 635 Campbell Technology Parkway Campbell, CA 95008 D (408) 558-4338 T (408) 558-7500 C (703) 328-4180 christine.ballard@mossadams.com

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