This article describes a combination of resources available to small and medium sized US-based businesses exporting to foreign markets, through a range of US tax incentives and governmental financial and insurance products. Many small to medium size businesses do not utilize these governmental resources at all, or at least not to the extent they otherwise could, so I am going to outline some of these options in a series of posts.
I’ll start today with a brief history of DISCs and the tax benefits they offer US exporters. Congress first created Domestic International Sales Corporations (DISCs) in 1971 as special purpose companies. This distinction allows US exporting companies to legally defer and reduce taxes on export related income. Congress was hoping to promote economic growth, as well as create tax parity with foreign exporters receiving value added tax benefits on border taxes. Congress and the IRS eventually eliminated the tax benefits of DISCs to large US exporters. Other nations complained over the intervening decades that DISCs violate WTO agreements prohibiting governmental market interference. An income tax regime referred to as “IC-DISCs” is the current result of the WTO dispute process provided by the US government that allows U.S. exporters to defer recognition on a maximum of $10,000,000 in “qualified export receipts,” which may be calculated under a several different formulas.
The term “IC-DISC” originates from the 1984 Deficit Reduction Act (DEFRA) that added an “Interest Charged” component to the DISC regime. An IC-DISC modifies the DISC structure by levying a small tax in the form of an interest charge at the US T-Bill rate on the deferred income held within the IC-DISC, which is currently a fraction of a percent.
Individuals and pass-through entities form most IC-DISCs directly, because IC-DISC income may be received by individuals at the 15% qualified dividends rate. The most recent 2008 IRS statistics report that out of the approximately 1,917 IC-DISCs, 86.1% of them were majority-owned by individuals, partnerships, trusts, estates, or S corporations. IC-DISCs received $4.7B in gross receipts, with $4.5 in deferred taxable income1.
US exporters benefit from IC-DISCs primarily through two mechanisms. First, they allow the indefinite deferral of taxation on qualified US export receipts, subject to a negligible interest charge. Second, they enable companies to both deduct payments to IC-DISCs and distribute that income to common shareholders of the exporting company and IC-DISC at the 15% qualified dividend rate. While the favorable 15% qualified dividend rate may not be provided by Congress in the future, this distribution benefits IC-DISC owners regardless by effectively bypassing corporate level taxation on the IC-DISC income, and allowing for a single level of taxation on income in the hands of individual shareholders.