If you export goods that are manufactured in the United States, you can defer the U.S. income taxes on 1/2 of the profit on those sales and realize substantial current tax-savings. This can be accomplished by organizing a Domestic International Sales Corporation (DISC).

A DISC is merely a statutorily created entity designed to promote exports. It does not need to have employees or operating assets, but it must be capitalized with a minimum of $2,500.

A DISC is a U.S. corporation which usually operates as a commissioned sales agent for a distributor. The DISC may operate in other capacities, but it has been our experience that the commissioned sales agent is the simplest and most cost-effective method.

The deferral is available on 1/2 of the profits realized on up to $10 million of export sales. The deferral period can be indefinite, however, eventually the U.S. income taxes will be paid. But the time for payment of the income tax is mostly under your control. There will be an interest charge on the deferred tax liability, but this interest charge is nominal when compared to the tax-savings realized by the exporter.

The current tax-savings is the result of paying to the DISC a commission of 1/2 of the profit on the export sales. The DISC is exempt from U.S. income taxes and therefore does not pay U.S. income tax on the commission income. The exporter deducts the commission on its U.S. income tax return and thereby creates current tax savings. The example on this page illustrates how the tax savings is accomplished.

The DISC's net income will be taxable when it is distributed to its shareholders as dividends. Until that time, the DISC may loan its excess cash to the exporter. With proper documentation, the loan is not considered a dividend and therefore does not create taxable income to the exporter. Since the shareholders of the DISC, usually the exporter, determine when dividends are declared and paid, the shareholders control when taxable income is to be recognized.

Additionally, a DISC can be used as a valuable estate planning device. If the DISC is established with children or grandchildren of the exporter's owners as the DISC shareholders, the exporter's owners may transfer value from their estates through payment of the DISC commission and arguably avoid estate taxes on this transfer of wealth.

While the DISC is subject to various qualification rules, none of the rules are extremely difficult to meet. However, there may be some short-term financing arrangements to be made at the end of the year to maintain the DISC's qualified status.

The DISC can be formed as a subsidiary of the exporter, or as a sister corporation owned by the exporter's owners and/or their families.

The DISC can qualify for the tax benefit on 50% of the profits of export sales of up to $10 million annually. The tax benefit operates as a tax deferral (similar to an IRA or qualified retirement plan). The DISC itself is not subject to U.S. income tax, but the shareholders of the DISC will at some point be taxed on the DISC income. Taxes will be paid on the DISC commission only if the income is paid out to the shareholders, or if the DISC terminates business, liquidates or otherwise ceases to qualify as a DISC.

It is generally not difficult to maintain DISC qualification, and to continue the tax deferral, as long as the DISC does not permanently discontinue exporting. Furthermore, even if the DISC ceases exporting, the DISC status and tax deferral may be structured to continue indefinitely with proper maintenance.

If the DISC income becomes taxable to the shareholders because the DISC ceases to meet DISC qualifications or revokes its election, the deferred income may be taxable over a 10 year period (or over a period equal to twice the number of years the corporation qualified as a DISC, if less than 10 years). Therefore, in addition to the indefinite income tax deferral, the shareholders may, upon termination of the DISC, receive the benefit of reporting the deferred income over 10 years rather than reporting the income as a lump sum in a single year. Some states (such as Georgia and South Carolina) follow federal law and also appear to recognize the tax exempt status of the DISC. Accordingly, state taxes on the income should also be deferred indefinitely.

The DISC is not required to have employees or operating assets. The DISC is merely a statutorily created entity designed to promote exports. Establishing a DISC will not materially affect normal exporter operations. Accounting for DISC sales is required to be performed annually within 60 days after the close of the taxable year. Otherwise, virtually no additional accounting or bookkeeping work is required.

©2000 by Gomel & Davis, LLP. All rights reserved.

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