How a Producer’s Loan Can Enhance IC-DISC BenefitsAugust 09, 2016
A producer’s loan allows an exporter to cash in on an IC-DISC’s tax-deferral benefits while still reinvesting the IC-DISC’s earnings into his or her business.
In previous blogs, we’ve discussed how an interest charge domestic international sales corporation (IC-DISC) provides significant tax-saving opportunities for U.S. exporters, especially when combined with accounts receivable factoring. Another tool that can enhance an IC-DISC’s benefits is a producer’s loan.
How It Works
An IC-DISC provides two types of tax benefits. First, it converts ordinary income into tax-advantaged qualified dividend income. Second, it allows an exporter to defer taxes on up to $10 million in qualified export receipts held by the IC-DISC.
A producer’s loan enables an exporter to take advantage of an IC-DISC’s tax-deferral benefits while still reinvesting the IC-DISC’s earnings into the business. In a nutshell, the IC-DISC lends its accumulated earnings back to the exporter in exchange for a written promissory note. Interest payments are tax-deductible by the exporter and treated as deemed distributions to the IC-DISC’s shareholders. Essentially, this technique allows the exporter to reduce its after-tax cost of capital.
To preserve these benefits, producer’s loans must meet several requirements. Among other things, loans can’t exceed accumulated IC-DISC earnings. Producer’s loans also must adhere to prescribed terms. That is, qualifying loans must mature in five years or less and incur interest at market rates.
Weigh Your Options
It’s important to evaluate the costs and benefits before using this strategy in light of current preferential tax rates on qualified dividends. This strategy doesn’t work for every exporter. If you’re concerned that tax rates on qualified dividend income will increase in the near future, for example, you may be better off distributing IC-DISC earnings now to lock in the lower tax rate.
Typically, the shareholders of the IC-DISC are the same as the shareholders of the exporter, but sometimes they’re owned directly by a C corporation. In that case, qualified dividend treatment isn’t a concern, since corporations don’t enjoy a lower tax rate on dividends received.
An IC-DISC can be an effective way for manufacturers and distributors who engage in exporting activities to lower their tax bills — and they may be able to reap even more tax benefits by adding a producer’s loan to the mix.
Our team of global tax specialists can help set up and administer an IC-DISC to maximize the benefits and minimize the risk of IRS scrutiny.