The Interest Charge Domestic International Sales Corporation (IC-DISC) is a federal tax incentive designed to encourage American companies to increase their export sales. Authorized by Congress, the structure helps U.S. businesses compete in global markets by offering favorable treatment on export-related income. The IC-DISC mechanism allows qualifying exporters to shift a portion of their income from high-taxed ordinary business income into income taxed at a lower, preferential rate. This specialized entity is not an operating company but exists solely to facilitate this tax advantage.
Defining the IC-DISC Structure
The IC-DISC is established as a domestic corporation, typically a C corporation, to act as a commission agent for a related U.S. operating company (OpCo). It is often called a “shell” or “paper” corporation because it does not require employees, office space, or direct involvement in manufacturing or selling goods. It exists primarily as an accounting mechanism to re-route income for tax purposes, operating separately from the exporter it serves.
The Internal Revenue Code authorizes the IC-DISC to be exempt from federal corporate income tax on the income it receives. This means the IC-DISC acts as a conduit: income flows through the entity without being taxed at the corporate level, deferring taxation until the funds are distributed to its shareholders. The shareholders of the IC-DISC are usually the same individuals or entities that own the operating company, establishing a common ownership structure.
The Mechanism of Export Commission
The core function of the IC-DISC is to generate income through a commission paid by the related operating company based on Qualified Export Receipts (QER). The operating company treats this commission payment as a tax-deductible business expense. This deduction reduces the OpCo’s taxable ordinary income, which would otherwise be taxed at the company’s standard rate.
The maximum permissible commission the OpCo can pay the IC-DISC is determined annually by the greater of two calculation methods.
Calculation Methods
The first method allows the commission to be calculated as four percent of the Qualified Export Receipts generated by the OpCo’s export sales. This approach is often beneficial for companies with high sales volume but lower profit margins.
The second method allows the commission to be calculated as fifty percent of the combined taxable income derived from the export sales. This option is generally more advantageous for exporters who maintain high profit margins. The operating company can choose the method that maximizes the deductible commission each year, often on a transaction-by-transaction basis. Since the IC-DISC is tax-exempt, the commission it receives is not subject to federal income tax at the corporate level, creating the initial tax deferral.
Realizing the Tax Benefit
The income received tax-free by the IC-DISC is ultimately distributed to its shareholders, where the tax benefit is fully realized. This distribution is classified as a qualified dividend for tax purposes. The fundamental advantage is the conversion of the income stream: the funds were deducted from the operating company’s income at the ordinary business tax rate, but they are taxed to the shareholder at the lower qualified dividend rate.
Shareholders pay tax on qualified dividends at preferential long-term capital gains rates, which are much lower than ordinary income tax rates. For example, the maximum rate for qualified dividends is often around 23.8%, including the 20% capital gains rate plus the 3.8% Net Investment Income Tax. This difference between the deduction rate and the dividend taxation rate creates a permanent tax savings for the exporter and its owners.
The name “Interest Charge” stems from a requirement concerning deferred income not immediately distributed to shareholders. Shareholders must pay an annual interest charge on the deferred tax liability attributable to the IC-DISC’s income. This charge applies only to IC-DISC income generated from Qualified Export Receipts exceeding $10 million. The interest rate is calculated based on the one-year Treasury bill rate.
Eligibility and Maintenance Requirements
To qualify and maintain its status, a corporation must meet strict requirements set forth by the Internal Revenue Code. The entity must be a domestic corporation, organized under the laws of any U.S. state or the District of Columbia. It must also have a simple capital structure, requiring only one class of stock with a minimum par or stated value of at least $2,500.
The IC-DISC must satisfy two annual quantitative tests to retain its tax-exempt status.
95% Gross Receipts Test
This test mandates that at least ninety-five percent of the corporation’s gross receipts must be from Qualified Export Receipts. These receipts include income from the sale or lease of U.S.-made export property and related services.
95% Qualified Export Asset (QEA) Test
This test requires that at least ninety-five percent of the adjusted basis of the IC-DISC’s total assets must be Qualified Export Assets. QEA includes trade receivables from export sales and working capital related to export activities. Failure to meet either test can sometimes be remedied by making a “deficiency distribution” to shareholders after the close of the tax year. The IC-DISC must also file an annual information return with the IRS using Form 1120-IC-DISC.