What Is an IC-DISC and How Does It Work?

An Interest Charge Domestic International Sales Corporation, or IC-DISC, is a corporate structure that provides a federal tax incentive for businesses exporting goods or services. The structure allows exporters to achieve permanent tax savings on a portion of their income from foreign sales. An IC-DISC is a separate legal entity, but it is often called a “paper entity” because it does not require its own office space or employees to function. The incentive is available to many businesses, including C corporations, S corporations, and partnerships engaged in exporting.

Qualifying for IC-DISC Status

To qualify as an IC-DISC for federal tax purposes, a corporation must meet specific organizational requirements. The entity must be a C corporation formed under U.S. state law and maintain only one class of stock. The corporation must also have at least $2,500 in par or stated value of outstanding stock at all times.

A corporation must also satisfy two annual financial tests, the first being the 95% qualified gross receipts test. This test requires that at least 95% of the corporation’s gross receipts for the tax year are “qualified export receipts” (QER). QER includes income from the sale or lease of “export property” for direct use outside the United States. Export property is defined as property manufactured, produced, grown, or extracted in the U.S. by a party other than the IC-DISC, with at least 50% of its value from U.S. content.

QER also encompasses receipts from services related to those sales, such as installation or maintenance. It can also include income from engineering or architectural services for construction projects located outside the United States.

The second requirement is the 95% qualified export assets test. This test dictates that at the close of the tax year, at least 95% of the IC-DISC’s assets must be “qualified export assets.” These assets are tied to the company’s exporting business and include the inventory of export property, trade receivables from qualified sales, and cash held for distribution as a qualified dividend.

Assets used in the exporting business, such as equipment for packaging or transportation, also count toward this test. Another qualified asset is a “producer’s loan,” which is a loan made from the IC-DISC’s accumulated commission income back to the U.S. parent company to finance its export-related assets.

Calculating the Commission Payment

The financial benefit of an IC-DISC is realized through a commission payment from the operating company to the IC-DISC. The IC-DISC acts as a commission agent, earning this income based on the qualified export sales of the parent company. The Internal Revenue Code provides specific methods for calculating the maximum allowable commission, allowing taxpayers to optimize their tax savings.

The two most common methods are based on the company’s income or its gross receipts from export sales, and the choice can be made annually or on a transaction-by-transaction basis.

One calculation is the 50% of combined taxable income (CTI) method. Under this approach, the commission equals 50% of the net profit from qualified export sales. This method is often best for companies with high-profit margins, but it requires careful accounting to segregate the revenues and expenses associated with export activities.

The alternative method allows for a commission equal to 4% of qualified export receipts (QER). This calculation is based on gross revenue from export sales, not net profit. This method is advantageous for businesses with high sales volumes but lower profit margins and does not require the detailed expense allocation of the CTI method.

For example, consider a U.S. manufacturer with $2,000,000 in qualified export receipts and a combined taxable income of $300,000 from those sales. The 4% of QER method yields a commission of $80,000 ($2,000,000 x 4%). The 50% of CTI method results in a commission of $150,000 ($300,000 x 50%). In this case, the company would choose the CTI method to pay a $150,000 commission.

Tax Implications for Shareholders

For the operating company, the commission paid to the IC-DISC is a business expense that directly reduces the company’s ordinary income. This income would otherwise be subject to regular corporate or individual income tax rates, depending on the entity’s structure.

The IC-DISC itself is a tax-exempt entity at the federal level, so the commission income it receives is not subject to federal income tax. The profits can accumulate within the IC-DISC without immediate tax consequences.

The tax benefit is realized when the IC-DISC distributes its accumulated earnings to its shareholders as qualified dividends. For shareholders, qualified dividends are taxed at preferential long-term capital gains rates, which are lower than the top marginal rates on ordinary income. For example, the highest federal tax rate on qualified dividends is 20% (plus a potential 3.8% Net Investment Income Tax), whereas ordinary income can be taxed at rates up to 37%. This difference between the deduction at ordinary rates and taxation at qualified dividend rates creates a permanent tax savings.

The “Interest Charge” in the name refers to a provision related to tax deferral. Shareholders can defer receiving dividends on accumulated IC-DISC income from up to $10 million of qualified export receipts annually. If distributions related to export receipts above this $10 million threshold are deferred, shareholders must pay a nominal interest charge to the IRS on the deferred tax liability.

Establishing and Maintaining the IC-DISC

The first step in establishing an IC-DISC is to form a new C corporation under the laws of a U.S. state. This entity must be legally distinct from the operating company it will serve, even if the ownership is identical.

After forming the corporation, a formal election must be made to be treated as an IC-DISC for tax purposes by filing Form 4876-A with the IRS. The form requires information such as the corporation’s name, Employer Identification Number (EIN), and the effective tax year. All shareholders must consent to the election in writing on the form.

The timing for this election is strict. Form 4876-A must be filed within the 90-day period immediately preceding the beginning of the first tax year for which the election is effective. For a new corporation, this means filing within 90 days of its incorporation. Failure to meet this deadline will prevent the corporation from being treated as an IC-DISC for that year.

Ongoing compliance includes executing a formal written exporter’s franchise agreement between the operating company and the IC-DISC. This document outlines the commission arrangement and formalizes their relationship. Annually, the IC-DISC must file Form 1120-IC-DISC, an informational tax return reporting its qualified receipts, assets, commissions, and any dividends paid.

The IC-DISC must also maintain its own separate bank account and financial records. The operating company must make an actual cash payment of the commission to the IC-DISC’s bank account. When the IC-DISC pays a dividend, it must make a physical distribution of funds from its account to the shareholders. These steps demonstrate that the IC-DISC is a legitimate, separate entity.