If you export products for sale of any type and don’t know what an IC-DISC (or simply a DISC) is, or think it’s a round piece of plastic you put in your computer’s drive, then keep reading. Any United States business with qualifying export sales can save a large amount of money with the use of a Interest Charge Domestic International Sales Corporation (referred to hereinafter as a “DISC”).
Here’s how it works. The exporting entity stays the same, no changes are made to the entity, the way it sells products or anything else. A separate corporation is formed under the laws of any state, which then files Form 4876-A, which is the election to be treated as a DISC for federal tax purposes (most states, like New York, have provisions allowing for the same treatment but you have to check on a state by state basis).
The DISC is usually owned by the same shareholders of the exporting company, although it can be others, if the company wants to compensation employees or family members. It can be anyone.
As per the statutory authority on DISCs (IRC 991 et. seq. & promulgated regulations), the DISC entity can only have one class of shares and it should have a minimum of $2,500 as stated capital. I generally have the par value match up to this amount, and issue all shares. The DISC should have a separate bank account from the exporting company and the $2,500 should be placed into the account upon opening.
Upon creation of the DISC, it and the exporting company also must enter into a Commission Agreement which will dictate how export income is allocated between the DISC and the exporting company based on the tax law. The DISC, by law, can only take limited actions and can have only limited business activities.
At the end of a tax year, the exporting company’s accountants will calculate what the interest charge is which is paid to the DISC by the exporting company. The tax rules provide for two safe harbors which the company can use to ensure it will get the desired tax treatment. The two safe harbors are that the DISC can be paid using one of the two following methods, whichever is greater:
- Gross Receipt Method – 4%
The DISC can be paid a commission equal to 4 percent of the qualified export receipts of the DISC and the exporting company; or
- Taxable Income Method – 50 %
The DISC can be paid a commission equal to 50 percent of the combined taxable income of the DISC and exporting company.
The interest commission that is paid to the DISC (based on the amount which is based on the greater of the two tests above) is a tax free payment to the DISC, and is deducted by the exporting company. The cash in the DISC can be distributed out to the DISC shareholders as they deem fit, and will be taxed at the capital gains rate.
Like many tax issues there are various caveats that taxpayers must be weary of. But if your company has export sales, you should definitely look into the possibility of forming and using a DISC.