COVID-19-driven modifications to supply chains and tax laws have changed how exporters evaluate the benefits of an IC-DISC. Here’s what you need to know about the new calculation.
You may benefit from advanced strategies that can make the IC-DISC even more valuable.
IC-DISC tax law changes
Exporters can realize valuable tax savings using an IC-DISC. This entity is a C corporation that makes a special election and typically exists in form only — it needs to meet only a few minimal substance requirements. An exporter of domestically manufactured property pays a commission expense to the DISC, which reduces the exporter’s taxable income. The DISC, which isn’t a taxpaying entity, then pays out its earnings as a qualified dividend to its U.S. shareholders.
Most DISC structures result in tax savings through the tax rate arbitrage between ordinary income and the qualified dividend rate, or by allowing a C corporation to effectively deduct dividend payments. The rate changes enacted under the Tax Cuts and Jobs Act did reduce the tax advantages that this structure provides to some extent, but legislative and economic changes in response to COVID-19 have served to restore some of the value to the IC-DISC strategy.
Paycheck Protection Program (PPP) and IC-DISC
The Coronavirus Aid, Relief and Economic Security (CARES) Act’s Paycheck Protection Program (PPP) has added an additional benefit to the IC-DISC calculation. The PPP created a new loan for U.S. businesses that could be easily forgiven if the business meets certain criteria. However, if the business takes advantage of the forgiveness feature, it can’t deduct expenses that were paid using the PPP funds. An IC-DISC can help recover the tax savings lost from foregone deductions by increasing the exporter’s allowable commission deduction.
Net operating loss (NOL) carrybacks
The CARES Act also brought back NOL carrybacks for a limited time. The commission deduction that the exporter pays to an IC-DISC can help to create or increase an NOL that can be carried back to generate a refund.
Supply chain changes and IC-DISC
With COVID-19 wreaking havoc on global supply chains, many exporters have been forced to find new sources for the materials that go into the goods they send overseas. Because the IC-DISC commission calculation is based on percentages of net export income from products meeting domestic content thresholds, exporters who have tapped into new domestic supplies may have increased their qualified export percentages. For those who may have considered using this entity in the past and dismissed it, a significant on-shoring of the supply chain into the United States could modify the commission calculation and tip the scales in favor of implementing an IC-DISC.
In addition to the basic math of tax rate arbitrage and increased deductions, IC-DISCs also enable exporters to participate in more advanced strategies that can help to optimize their tax positions. With tax savings more important than ever, transaction-by-transaction optimization strategies may enhance the benefits of an IC-DISC. Eligibility and qualification for these advanced strategies will depend on the individual facts and circumstances of each taxpayer, but they should be part of the conversation when exporters discuss IC-DISCs with their tax advisors.
To learn more about IC-DISCs and find out how they might help your export business manage the economic upheaval caused by the COVID-19 pandemic, please contact your Plante Moran advisor.