The two-year tax reduction bill enacted in December, PL 111-312, extended the 15% tax rate on qualified dividends. This also extended the benefits of IC-DISC (or DISC). Using a DISC, exporters of US-made goods get a subsidy of at least 10% of their earnings on those exports. If your business sells $1 million or more of US-made products for use outside the US, you need a DISC. You can make a profit regardless of whether your business manufactures or simply distributes the products. The benefit applies to partnerships, corporations and even sole proprietors.
This is good news for all exporters, who can still receive an export subsidy. The 15% dividend tax rate and the regular tax deduction (often at a 35% tax rate) of DISC commissions combine to reduce federal income taxes. This export subsidy is at least 10 percent of export profits. The subsidy also applies to architectural and engineering services for construction projects outside the US, but not to most other services. To get this export subsidy, you must have a separate paper company that chooses DISC status. Must be in effect before goods are sold or construction services are billed.
DISC is NOT avant-garde, aggressive or risky. It has been around since 1971, but saw limited use from 1984 to 2003, when the tax rate on dividends changed. Congress stated during the Bush administration that they wanted to keep DISC and the benefits for middle market exporters.
Several things are required for your business to obtain this grant. There must be a separate US corporation that has filed an IRS election to be treated as a DISC. It is purely a paper corporation with $2,500 of capital and no other substance. This corporation must have agreements with commercial operating entities to obtain a commission. The commission is calculated according to complex IRS rules based on export sales or the net profit from those sales. The business gets a federal income tax deduction for this fee. DISC does not pay taxes on your income. The DISC can defer some earnings, but must distribute the rest. The ultimate tax payment to shareholders at the rate of 15% instead of the regular federal income tax rates on commission distributed. This results in a federal tax rate differential of up to 20%.
Simple example: Smitty’s Plumbing Supply sells $3 million worth of Ohio-made pipe fittings to customers in Windsor, Ontario. Smitty’s net profit margin is 8% overall, so he earned $240,000 from Ontario sales. Smitty, the owner, is in the 35% tax bracket. Without a DISC, Smitty would pay $84,000 in federal income tax on export earnings. If Smitty had a DISC, he could reduce that tax by at least $24,000.
The commission calculation in its simplest form can be done on a Post-It(tm) note, but the result is likely to be less than optimal. Various techniques can increase the benefit. These include the application of the rule of “no loss”, the percentage of total profit or the “marginal cost”. These techniques add to the complexity and cost of doing the calculation, but for sufficient sales volumes they can be very worthwhile. Optimizing these calculations in a way that the IRS approves requires experience. For very large transaction volumes, specialized software may be required. For many mid-market companies, these additional costs are trivial compared to the additional tax savings from DISC optimization. Consider each year whether the optimization calculations are worth it.
If you’re an exporter of US-made products, DISC can probably help you, but you need help setting up a DISC and calculating the best profit. A new corporation is needed, as the DISC election must be held at the beginning of the DISC fiscal year. In addition, the DISC and the business entity must have the appropriate agreements in place, and the DISC must have an “evergreen” dividend resolution. The lack of a key piece can end your profit.
Remember, DISC savings start only when the new DISC is in place. Act now to start getting these tax benefits by calling Steve Fox.
