In Part 1, we explained what an Interest Charge Domestic International Sales Corporation (IC-DISC) is and how it can provide tax savings for qualifying U.S. exporters. Now, in Part 2, we’ll walk through how to structure an IC-DISC, how to calculate commissions, and what’s required to maintain compliance.
This article is ideal for business owners, CFOs, and advisors ready to explore implementation and assess whether an IC-DISC fits their strategic tax planning.
Choosing the Right Commission Calculation Method
An IC-DISC receives a commission from the operating company based on qualified export sales. There are two primary calculation methods, and companies can choose the more favorable option each year:
- 4% of Gross Receipts: This method applies a flat 4% commission based on the company’s qualified export sales. It’s typically used by businesses with high revenue but low profit margins.
- 50% of Combined Taxable Income: This method calculates the commission as 50% of the combined taxable income from export sales (shared between the IC-DISC and the operating company). It’s generally more beneficial when profit margins on exports are high.
Key Takeaway: Annual flexibility allows companies to choose the method that maximizes the tax benefit based on current financial performance.
Structuring the IC-DISC
The IC-DISC must be a U.S. corporation, taxed as a C corporation, and often owned by the same individuals or entities that own the operating company. Ownership structure plays a critical role in how the tax benefits are realized.
Option 1: Parent-Subsidiary Model
- The IC-DISC is a wholly owned subsidiary of the operating company.
- Commissions are paid from the operating company to the IC-DISC.
- The IC-DISC distributes dividends back to the operating company.
This structure is effective if the operating company is a partnership or S corporation subsidiary. It is not recommended for a C corporation to wholly own the IC-DISC
Option 2: Direct Ownership Model
- The IC-DISC is owned directly by the individual shareholders or partners.
- Dividend income flows through to the owners and is taxed at the qualified dividend rate.
This model is often favored by closely held businesses because it provides greater flexibility in distributing income tax efficiently.
Compliance Note: Regardless of structure, IC-DISC status must be maintained by adhering to IRS requirements, including timely filings, proper recordkeeping, and qualified export activity.
Example: Which Method Delivers Greater Tax Savings?
Consider a company with $20 million in qualified export sales and $5 million in net export income from those sales. If the company has an IC-DISC that’s owned by the same shareholders, it can calculate the commission using either method:
- 4% of gross export receipts: 4% of $20 million = $800,000
- 50% of net export income: 50% of $5 million = $2.5 million
In this scenario, the company would choose the 50% method, as it yields a higher commission and, in turn, a larger tax deduction for the operating company. This will result in tax savings of about $425,000 compared to not using an IC-DISC.
| Example without IC-DISC | Example with IC-DISC | ||
| Net export income | $5,000,000 | Net export income | $5,000,000 |
| Individual Tax Rate | 37% | Commissions | (2,500,000) |
| Tax | $1,850,000 | Net income after commissions | $2,500,000 |
| Individual Tax Rate | 37% | ||
| Tax | $925,000 | ||
| Commissions are paid out as dividends | $2,500,000 | ||
| Tax rate | 20% | ||
| Tax | $500,000 | ||
| Total Tax | $1,425,000 | ||
Compliance: Maintaining IC-DISC Status
To retain IC-DISC status and preserve the associated tax benefits, companies must satisfy specific compliance requirements annually. Failing to meet these can result in disqualification and loss of tax-deferral opportunities.
Qualification Tests
To remain compliant, the IC-DISC must:
- Derive at least 95% of its gross receipts from qualified export property transactions (the 95% gross receipts test), and
- Hold at least 95% of its assets as qualified export assets (the 95% assets test).
Qualified income includes sales, leases, or commissions on U.S.-manufactured goods sold outside the country. Qualified assets typically include receivables from export sales and temporary investments of those proceeds.
Filing and Documentation Requirements
The IC-DISC must file an annual U.S. income tax return using Form 1120-IC-DISC by the 15th day of the 9th month after the close of the tax year (typically September 15 for calendar-year filers). Timely and accurate filing is essential to maintain tax-exempt status.
Supporting documentation—such as sales agreements, shipping records, and income allocation reports—must be retained and available for IRS review. Accurate transfer pricing calculations and commission agreements with related operating entities should also be on file.
Dividend Distributions and Reasonable Returns
IC-DISCs are required to pay dividends to shareholders from their accumulated earnings. Best practices include establishing a formal dividend policy and ensuring that commissions paid to the IC-DISC reflect a reasonable return based on IRS-approved methods. Missteps in this area can trigger scrutiny or adjustments.
Ongoing Monitoring and Best Practices
To protect IC-DISC status:
- Conduct an annual compliance review to confirm that income and assets continue to meet the 95% thresholds.
- Coordinate with your legal and tax advisors on any material changes to operations, such as shifts in customer base, manufacturing processes, or asset holdings.
- Keep corporate formalities and accounting records up to date, especially in situations where the IC-DISC is closely held or passive.
How CPM Can Help
The IC-DISC structure presents a compelling tax strategy for U.S. businesses engaged in international trade. By reducing taxable income and shifting income to shareholders through qualified dividends, companies can lower their overall tax liability and free up capital for growth. However, the complexity of setting up and maintaining an IC-DISC requires careful consideration of the business’s structure and financial situation.
At CPM, we assist clients with IC-DISC compliance, including annual filing reviews, qualification testing, and coordination with CPAs and tax professionals. We also advise on structuring commission agreements and responding to IRS inquiries when needed. We aim to simplify the complexity—so you can focus on global growth while we ensure your IC-DISC stays on solid ground.
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