THE IC-DISC EXPORT INCENTIVE

1. THE OHIO SOCIETY OF CPAs CLEVELAND ACCOUNTING SHOW THE IC-DISC EXPORT INCENTIVE TAX SAVINGS FOR CLOSELY HELD MANUFACTURERS AND DISTRIBUTORS George Elias, CPA Premier tax Consulting, LLC Office:330-225-7034 Cell: 216-577-0916 george.elias@premiertaxllc.com

2. Overview • An increasing number of closely held companies are using the often overlooked IC-DISC (Interest Charge Domestic International Sales Corporation) provisions of the Internal Revenue Code intended to help U.S. companies compete internationally. • Many, however, are still not utilizing this federal government incentive, or not capturing all of the available, intended and allowable benefits. • The AICPA, OSCPA, and the federal government itself are facilitating and encouraging taxpayers to explore and take advantage of the IC-DISC. george.elias@premiertaxllc.com

3. History of Export Incentives • DISC - (Domestic International Sales Corporation) 1971-1984 • FSC - (Foreign Sales Corporation) 1985-2000 • ETI - (Extraterritorial Income Exclusion) 2000-2006 • IC-DISC - (Interest Charge Domestic International Sales Corporation) 1984 to Present • The DISC, FSC, and ETI were all phased out due to opposition from our trade partners such as the GATT, EU, and WTO over the years (concluding with the phase out of the ETI in 2006). • The IC-DISC has not only survived, but has become more powerful due to the “qualified dividend” rates of the 2001 Bush tax cuts. george.elias@premiertaxllc.com

4. What is the IC-DISC ? • Tax incentive created by Congress to encourage exports. • Originally created to provide a deferral mechanism, in 2001 the IC-DISC began to provide a permanent tax savings via the qualified dividend rate (currently 15% maximum) to closely held exporters. This was due to the Bush tax cuts. • At least 50% of Taxable Income, or 4% of Gross Receipts (limited to taxable income) from products made in and used outside the U.S are taxed at a 15% dividend tax rate instead of the 35% top tier ordinary income tax rate. george.elias@premiertaxllc.com

5. Steps to Implement an IC-DISC? • Requires setup of a corporation which elects treatment as an IC-DISC by filing Federal Form 4876-A within 90 days of setting up a corporation. • Requires creation of specific inter-company agreements between the IC-DISC and the IC-DISC owners. • Requires computation of the IC-DISC Commission (Multiple methods to compute the DISC commission). • Annual filing of a 1120-IC-DISC tax return. Return due 9/15 each year. No extension required. • No change in business operations needed. Transparent to customers. • Requires journal entries and movement of cash between entities. george.elias@premiertaxllc.com

6. Typical Structure for Flow Through Entities Individual Owner(s) US Operating Company Taxed at Ordinary Rates, Typically 35% IC-DISC Commission Deduction Dividend, 15% Tax rate IC-DISC Tax Exempt Entity george.elias@premiertaxllc.com

7. Basic Benefits of an IC-DISC Calculationfor Flow through Entities george.elias@premiertaxllc.com

8. Typical Structure for Closely Held C Corp. Individual Owner(s) Dividend, 15% Tax Rate US Operating Company IC-DISC Tax Exempt Entity IC-DISC Commission Deduction Taxed at Ordinary Rates, Typically 35% george.elias@premiertaxllc.com

9. Basic Benefits of an IC-DISC Calculationfor a Closely Held C-Corp george.elias@premiertaxllc.com

10. What Products or Services Qualify for the DISC • Goods ultimately used outside the U.S. (directly or Indirectly) that was Manufactured, Produced, Extracted or Grown (MPEG) within the U.S. • Foreign Content Test – No more than 50% of foreign content allowed in products (Foreign Content Costs/FMV = % of Foreign Content). • U.S. Manufactured Test – Safe harbor 20% of costs must be U.S. labor or factory burden. Taxpayer does not have to be a manufacturer! Distributors qualify. • Products must not be further manufactured within the U.S. by another party before export. Further manufacture outside the U.S generally qualifies. • Certain services may qualify if intent is to build outside the U.S. Examples include Architectural or Engineering Services. george.elias@premiertaxllc.com

11. Benefits of a Detailed IC-DSIC Analysis Talk with a Specialist with knowledge of: • Qualification of IC-DISC Beneficiaries. • Identification of eligible activity (Sales). • Allocation and Apportionment of Expenses. • Transactional by Transactional (TxT) calculations. george.elias@premiertaxllc.com

12. Benefits of a Detailed IC-DSIC Analysis Qualification of IC-DISC Beneficiaries: • Care must be taken to ensure proper initial set up of the IC-DISC entity, required elections, preparation of shareholder agreements between the IC-DISC and the related supplier, etc. • Basic maintenance of the entity, required estimates of the IC-DISC commission, and preparation of all compliance documents (e.g. the Form 1120 IC-DISC and Schedule Ps) are recurring activities. • Accounting Firm personnel with knowledge of the concept and basic workings of the IC-DISC facilitate the process of utilizing the incentive. george.elias@premiertaxllc.com

13. Benefits of a Detailed IC-DSIC Analysis Identification of eligible activity (Sales): • IC-DISC eligible sales are often not traditional “export” sales. Customers need not be foreign. • For example the following items have qualified for export incentives: • Property sold to the U.S. Military used overseas. • Transportation property used predominantly outside the U.S. (e.g. Jet airplanes and certain parts sold to and flown by U.S. airlines). • Components sold to U.S companies and initially shipped to a U.S. location. • Orbiting satellites used by NASA. • Architectural plans for projects proposed for location outside the U.S. • Equipment rental outside the U.S. george.elias@premiertaxllc.com

14. Benefits of a Detailed IC-DSIC Analysis Allocation and Apportionment of Expenses: • Properly allocating expenses between domestic transactions and IC-DISC eligible transactions and documenting those allocations are permitted (similar to such an allocation made for Sec. 199 purposes). • Proper allocation of expenses often increases Net Income from IC-DISC eligible transactions. For Example, salaries for Sales Managers who only serve U.S. consumers do not have to be allocated to international transactions. george.elias@premiertaxllc.com

15. Benefits of a Detailed IC-DSIC Analysis Transactional by Transactional (TxT) calculations : • Calculating IC-DISC benefits at a transactional, rather than aggregate, basis can add significant increases. • Sophisticated calculation engines can maximize tax savings by dramatically increasing the IC-DISC benefit using the intended, allowable, complex methods in the regulations. These engines also generate the additional needed compliance. • Until 2006, public companies routinely enjoyed significant increases in their export incentive calculations from detailed analyses using calculation engines.  Now, such increased benefits are available to closely held companies through the IC-DISC. george.elias@premiertaxllc.com

16. Benefits of a Detailed IC-DSIC Analysis Transactional Analysis: • Loss Exclusion – Loss transactions may be excluded, allowing benefit to be derived from profitable transactions. • Marginal Costing – In conjunction with transactional analysis, marginal costing is an element of the IC-DISC regulations which allows less profitable transaction to derive IC-DISC benefit largely as if they were as profitable as an average transaction. • Marginal costing can be applied at transactional, product, product line, etc. levels. Highly sophisticated software is needed to optimize marginal costing benefits in conjunction with loss optimization. george.elias@premiertaxllc.com

17. Benefits of a Detailed IC-DSIC Analysis Transactional Analysis– Marginal Costing Example IC-DISC Commission Methods: 4% of Sales Method (100*.04) = $4 50% Net Income Method (8*.50) = $4 Marginal Costing Method (28/200 *100*.50) = $7 george.elias@premiertaxllc.com

18. Benefits of a Detailed IC-DSIC Analysis Benefit and Cost Summary: • Care must be taken to ensure proper initial set up of the IC-DISC entity, required elections, preparation of shareholder agreements between the IC-DISC and the related supplier, etc. Basic maintenance of the entity, required estimates of the IC-DISC commission, and preparation of all compliance documents (e.g. Form 1120-IC-DISC and Schedule Ps) are recurring activities. • Companies only spend a few hours per year gathering easily obtainable transactions from Sales and Cost systems. george.elias@premiertaxllc.com

19. Benefits of a Detailed IC-DSIC Analysis Benefit and Cost Summary (Continued): • Fully optimized IC-DISC calculation is a great benefit to closely held companies. Benefits far exceed basic calculation methods but require specialized software to be optimized. • Costs of optimization calculations vary depending on volume and complexity of the client and its business. Benefits are typically at least five times the cost and are significantly greater. • Benefits can only be claimed on a go forward basis once a DISC is established. george.elias@premiertaxllc.com

20. Legislative Backdrop and Outlook • The qualified dividend rate, which was recently extended with the Bush era tax cuts through 2012, has created renewed interest in the IC-DISC. • Both political parties have indicated strong support of the qualified dividend rate and encouraging exports. • Support from a bipartisan Senate consortium, IC-DISC benefactors, and service providers lobbied successfully to have the DISC preserved as a worthwhile incentive for U.S. production and exports of U.S. products. • As long as the spread remains between the qualified dividend tax rate and ordinary income tax rates the DISC will be alive and well past 2012. george.elias@premiertaxllc.com

21. Questions THANK YOU George Elias, CPA Premier Tax Consulting, LLC Office: 330-225-7034 Cell: 216+-577-0916 Email: george.elias@premiertaxllc.com george.elias@premiertaxllc.com