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1
IC-DISCs as a Tax Arbitrage and Wealth Transfer Strategy
By: Christine Ballard August 23, 2016
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 o IC-DISC shareholders are required to pay interest
on the deferral of income
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
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
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
COMMON STRUCTURES
Related Supplier
IC-DISC
Shareholder Shareholder
Commission Qualified Dividend
Example 1 - Passthrough
Taxed at
preferential
rate to
shareholders
Deductible
to supplier
7
COMMON STRUCTURES
IC-DISC Related Supplier (C Corporation)
Shareholder Shareholder
Commission
Qualified Dividend
Example 2 - Corporation
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
COMMON STRUCTURES
LLC
IC-DISC
Shareholder (Patriarch) Heirs
Commission
Qualified Dividend
Example 3 – Wealth Transfer
Related Supplier
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
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
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
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
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
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
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
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 [email protected]