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Turbocharge an IC-DISC with Accounts Receivable Factoring

July 11, 2016

A technique called “factoring,” or selling receivables to a third party at a discount, allows U.S. exporters to increase an IC-DISC’s tax-advantaged export revenues.

An interest charge domestic international sales corporation (IC-DISC) offers significant tax-saving opportunities for U.S. exporters. (See our previous blog.) By adding accounts receivable (A/R) factoring into the mix, you may be able to fuel even greater tax benefits.

Review of IC-DISCs

An IC-DISC is a tax-exempt “paper” corporation set up to receive commissions on export sales. Typically, the shareholders of the IC-DISC are the same as the shareholders of the exporter. The exporter pays tax-deductible commissions to the IC-DISC up to the greater of:

  • 4% of its gross receipts from sales of qualified export property, or
  • 50% of its net income on those sales.

Because the IC-DISC is tax-exempt, commissions aren’t taxed until they’re paid out to the IC-DISC’s shareholders in the form of qualified dividends. Essentially, this technique converts ordinary income, taxable at rates as high as 39.6%, into qualified dividend income, generally taxable at 23.8%.

There’s also an opportunity to defer taxes on up to $10 million in qualified export receipts held by the IC-DISC, in exchange for a modest annual interest charge.

Added Benefits of Factoring

The term “factoring” refers to the process of selling receivables to a third party at a discount. Often companies engage in A/R factoring to free up cash and eliminate the headaches associated with collections. Factoring can also be used to boost the benefits of an IC-DISC.

In a nutshell, A/R factoring increases the amount of income the exporter shifts to the IC-DISC. How does it work? The exporter sells export-related receivables to the IC-DISC at a discount, receiving an immediate cash payment and taking a loss on the discounted receivables.

The factoring income earned by the IC-DISC — which is recognized as interest income — is tax-exempt to the IC-DISC. And, when cash is distributed to the shareholders of the IC-DISC, the payments are taxed at the lower qualified dividend rate.

Essentially, factoring allows the exporter to reduce its income while increasing the IC-DISC’s tax-advantaged export revenues. In Revenue Ruling 75-430, the IRS ruled that factoring income received by an IC-DISC from a related exporting company constitutes qualified export receipts. To ensure that a factoring arrangement passes muster with the IRS, the discount should be comparable to those used in arm’s-length factoring transactions.

Getting Started

An IC-DISC can be an effective way for manufacturers and distributors that engage in exporting activities to lower their tax bills, especially when they’re turbocharged with A/R factoring. Our International Tax Services Team can help you set up and administer an IC-DISC to maximize the benefits and minimize the risk of IRS scrutiny.

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