While driving to the Wisconsin State Cranberry Growers Association Summer Trade Show event a couple of weeks ago, I was reminded how much our local farm communities rely on international markets to sell their products.
In the cranberry and dairy industries (and a lot of other agricultural industries as well), producers are always trying to create more demand for their products by coming up with new products or, more importantly, selling to new international markets. If you are one of those producers selling to new international markets, I have some ways to help you keep some of your new cashflow.
The Internal Revenue Code has tax savings tactics that producers can take advantage of if they are exporting their product to a foreign country. One of those tactics is called an interest charged domestic international sales corporation (IC-DISC). This law was passed by Congress to help increase U.S. exports.
Let’s go through a basic calculation to help illustrate if this tax benefit outweighs the cost of setting up an IC-DISC and satisfying the annual compliance.
The basic premise of an IC-DISC is the exporting company will pay a commission to the IC-DISC. The IC-DISC would then turn around and pay the commission out as a qualified dividend to the owners of the IC-DISC. The operating company gets an ordinary tax deduction for the commission, and the dividend is taxed at preferential capital gains rates. The IC-DISC isn't taxed on the commission it receives. The tax savings is the tax rate arbitrage between ordinary tax rates and capital gains rates.
Under the current tax code, the tax rate savings is 5.8% of the commission paid. Under pre-2018 tax law, the tax savings was 15.8% of the commission paid. The new tax code has obviously decreased the benefit, but there are still some good tax savings available for larger producers, and one thing we know for sure is the tax code will change at some point. Whether that change will make an IC-DISC more advantageous is yet to be seen.
To give you an idea of the benefit you could receive, here is the basic commission calculation. The commission is the greater of:
- 4% of total foreign sales,
- 50% of foreign taxable income, or
- Marginal cost percentage multiplied by foreign gross receipt multiplied by 50%
Unless you track each foreign transaction separately, typically the second and third calculation listed above are the same number.
These calculations show that the two key factors to determine the size of the commission is the amount of foreign sales, foreign sales as a percent of total sales, and taxable income. If you have a high percentage of export sales to total and have a large taxable income, an IC-DISC would be a good way to help save some taxes.
The goods sold by the producer need not be directly exported by the taxpayer, but the taxpayer must prove that the goods were ultimately exported without further processing within the U.S. That means producers who sell to an intermediary (e.g., grain elevator) who ultimately ships it to a foreign customer qualify as foreign.
With today’s tracking technology, all producers should be able to track where all of their crops or livestock are ultimately ending up before they are processed.
The foreign derived intangible income deduction
There is another tax savings technique available to C corporations that sell their product to foreign customers. This benefit is called the foreign derived intangible income deduction.
The deduction is equal to 37.5% of the income derived from foreign sales, dropping the effective tax rate for a C Corporation from 21% to 13.13% until 2025. After 2025, the deduction drops from 37.5% to 21.87%. Even if the IC-DISC doesn’t make sense for a smaller C Corporation, this deduction might help.
Leveraging export tax incentives
The big takeaway here is the U.S. government has put tax savings in place to help encourage producers to export their livestock or crops. If you have a high level of foreign-sourced sales along with a healthy amount of taxable income, you should be taking advantage of one of the tax savings techniques above.
If you have any additional questions about either of these tax savings, please contact me or your Wipfli relationship executive for more information.