Being close to international markets is a big draw for companies with operations in Florida, especially here in South Florida, where natural, world-class ports make access to foreign markets a given. In fact, Florida is home to more than 58,000 exporters, the second-highest number in the United States.
However, a large percentage of these exporters are missing a very valuable — and somewhat little-known — federal tax incentive for U.S. firms that can have a substantial effect on profitability, cash flow and return on investment. This tax incentive has been in the Federal Tax Code since 1971.
Specifically, the tax code currently allows qualified U.S. exporters to reduce corporate taxes by as much as 20 percent by establishing an IC-DISC (Interest Charge — Domestic International Sales Corporation). Although the name may seem unreal, the tax savings are very real — and will persist for the foreseeable future. Moreover, the structure is not difficult to set up, but it must be done correctly to qualify and pass muster with the IRS.
The different entity types that can use the IC-DISC include flow-through entities (S-Corps, partnerships, LLCs, etc.) and closely held C-Corps. It is important to note that you do not have to be the manufacturer of any products to take advantage of IC-DISC; you qualify if you export domestically produced products. Some of the industries that have taken advantage of the IC-DISC are distributors, software companies, and engineering/architectural firms working on building/structures in foreign locations.
The process to establish the IC-DISC is simple: A separate tax-exempt corporate entity (the IC-DISC) is formed alongside the current export company. Sometimes several entities are created to maximize the tax benefits. The export company pays commissions to the IC-DISC entity.
The commissions are deductible to the exporter, and the dividend payment of the commission income in the IC-DISC is taxed to the exporter’s shareholders/partners at the qualified dividend rate of 20 percent, as opposed to being taxed as ordinary income — top rate currently 39.6 percent.
Note, this IC-DISC dividend may be subject to the 3.8 percent Medicare surtax. Even with that imposition at the shareholder level, this tax arbitrage of approximately 20 percent on exported sales can mean a substantial increase in cash flow with minimal additional overhead.
For an even larger deferral, the IC-DISC can retain the commission payment and pay only the “interest charge” at the current base period T-bill rate. The applicable rate for 2014 is 0.15 percent — a fraction of a point!
This is a “paper” entity, and it is not required to perform substantial economic functions nor have employees or office space. Critically, a separate bank account and set of accounting records must be maintained, and an annual U.S. income tax return (1120-IC-DISC) must be filed.
Although many eligible exporters do not take advantage of this tax structure, many who have the tax structure in place neglect to take full advantage of all of the IC-DISC benefits. Additionally, many company owners do not think they qualify for IC-DISC status because they are not producing hard goods. Exporters should know that the benefits are also available to software, film, engineering and architectural firms, as well as many agricultural producers, with projects or sales in foreign markets. In fact, even companies that provide component parts of exported finished goods may qualify. Furthermore, additional options such as adding factoring and export outsourcing services can increase the overall tax benefit.
Importantly, the IC-DISC benefits only are available on a go-forward basis after the IC-DISC has been established, and there is no prior benefit or recapture for prior periods. For exporters, the time to act is now.
Enjoy your tax benefits — you earned them.
Raimundo Lopez-Lima Levi, CPA, CVA, CFF is managing partner, and Amy Preston, CPA, is tax director, with the certified public accounting firm Lopez Levi & Associates P.A. The firm is headquartered in Coral Gables, with offices in Homestead and Fort Lauderdale. The company website is www.lopezlevipa.com;
Lopez-Lima Levi can be reached at ray@lopez