1 IC-DISCs as a Wealth Transfer Strategy STEP By: Christine Ballard June 15, 2016

2 WHAT IS AN IC-DISC?  Interest Charge Domestic International Sales Corporation (“IC-DISC”) o Allows IC-DISC shareholders to defer tax on export related income o No federal taxation at the IC-DISC level o Taxes 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 o Ordinary income can be 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 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 WHO CAN BENEFIT?  Taxpayers can use IC-DISCs to get tax incentives available to manufacturers, producers, resellers, exporters of goods: o that are produced in the US; o with ultimate destination outside the US (sales to unrelated party); and o where the cost of foreign content does not exceed 50% of the sales price  Entities that sell “export property”  IC-DISCs are widely used by owner-managed and family-owned businesses

6 USES IN FAMILY WEALTH TRANSFER  Tax rate arbitrage opportunity  Converts ordinary income to qualified dividend, taxed at capital gain rates  Ability to push income and cash to another generation  Set-up usually not considered a gift

7 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

8 COMMON STRUCTURES Related Supplier IC-DISC Shareholder CommissionQualified Dividend IC-DISC Related Supplier (C Corporation) Related Supplier (C Corporation) Shareholder Commission Qualified Dividend Example 1 Example 2 Taxed at preferential rate to shareholders Deductible to supplier

9 COMMON STRUCTURES LLC IC-DISC Shareholder (Patriarch) Shareholder (Patriarch) Heirs Commission Qualified Dividend Example 3 Related Supplier Manager

10 DETERMINING THE COMMISSION AMOUNT  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)  The former is generally used when related supplier is selling a high volume with low profit margins  Commission (or reasonable estimate) should be paid within 60 days after the close of tax year

11 EXAMPLE – TAX SAVINGS IC-DISC Creates Tax Savings: Combined AlmondsWalnuts 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 % Foreign90%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 exporter39.60% 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

12 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

13 MAINTAINING IC-DISC STATUS  Qualified export assets under §993(b) include: o Export property o Assets used primarily in connection with the sale, lease, or other specified activities relating to qualified export property, and in connection with performing certain services o Sufficient cash required to meet the working capital requirements o Subject to limitations, amounts on deposit in the US to acquire other qualified export assets

14 CALIFORNIA CONSEQUENCES  FTB Ruling  “Unwinds” IC-DISC transactions  IC-DISC files its own California return  IC-DISC pays only $800 minimum tax

15 THANK YOU Christine Ballard CPA, MST Partner, National Tax International Tax Services MOSS ADAMS LLP 635 Campbell Technology Parkway Campbell, CA D (408) T (408) C (703)