—In These Challenging Economic Times, Taft’s Federal Tax Practice Group Continues to Assist Clients with Evaluating Cost Saving Strategies—

Congress has a long history of providing tax incentives to U.S. businesses that export goods to foreign markets.  Over the past decade, many of these export incentives have been repealed in response to challenges by the World Trade Organization that they violated various international trade agreements.  However, one such export regime, the Interest-Charge Domestic International Sales Corporation (“IC-DISC”), has received new life since the Bush Administration’s implementation of the fifteen-percent tax rate for certain qualifying dividends.

The IC-DISC structure is relatively simple in concept.  It permits the owner(s) of a closely-held U.S. company that exports goods to reduce the effective rate of tax on a portion of the company’s export sales.  Mechanically, the benefit is achieved by converting ordinary sales income into dividend income potentially taxable at a 15-percent rate.  Though the IC-DISC concept is relatively straight forward, taxpayers must implement some tax structuring in order to obtain the benefits.  The basic steps to implementing the IC-DISC structure are as follows:

• First, the shareholders of an existing operating company with export sales establish a new domestic corporation (i.e., a sister corporation) to serve as the IC-DISC. 
• Second, the IC-DISC and the operating company enter into a commission arrangement whereby the IC-DISC receives a “commission” with respect to the operating company’s export sales. 
• Third, the operating company pays the IC-DISC the appropriate commission.  The amount of the commission results in a deduction to the operating company and the IC-DISC is exempt by statute from federal income tax on its commission income. 
• Finally, the IC-DISC distributes the commission proceeds to its shareholders.  The dividend is taxable, but generally should qualify for the preferential 15-percent rate applicable to qualifying dividend income.

The amount of federal income tax benefit that may be achieved by employing an IC-DISC structure depends both on the amount of the operating company’s export sales and the amount of commission that may be imposed by the IC-DISC.  Generally, the commission is set by analyzing three potential formulas provided in the federal tax rules, and choosing the one that maximizes the benefit in a taxpayer’s particular circumstance.  Once the amount of the maximum commission is determined, the federal income tax savings equates to approximately 20 percent of the aggregate commissions paid.  The following hypothetical example demonstrates the potential tax savings for a domestic exporter with $5,000,000 in gross export sales that produce $1,500,000 in net profits before taxes.



It is important for taxpayers to realize that the IC-DISC structure is an intended export tax incentive, expressly sanctioned by Congress.  That is, the associated tax benefits do not represent aggressive tax planning strategies designed to “game” the federal tax system, but are intended tax benefits Congress enacted in order to encourage export sales.

Accordingly, the risks associated with the utilizing the IC-DISC structure generally relate to ensuring that the necessary intercompany agreements are drafted appropriately.  Additionally, there is some risk that Congress could revoke or reduce the benefits of the IC-DISC structure prior to December 31, 2010, when the fifteen-percent dividend rate will sunset.  Such risks are difficult to quantify, and should be understood fully by taxpayers before establishing an IC-DISC.

If your closely-held company intends to have significant export sales during 2009 and 2010 and expects to incur a federal income tax liability, please do not hesitate to contact a member of Taft’s Tax Practice Group to explore the potential benefits of establishing an IC-DISC.