IC-DISC Tax Benefits for Design Professionals Working Overseas
When you ask someone if they ever considered using an Interest-Charge Domestic International Sales Corporation (IC-DISC) they usually ask you to repeat yourself or to spell it. That’s too bad, because using an IC-DISC can provide significant tax benefits to U.S. architecture and engineering firms (AE firms) on their overseas projects. Many manufacturers that produce goods in the United States and export them are already taking advantage of this tax incentive.
But IC-DISC benefits may also apply to amounts received from providing architectural and engineering services on construction projects outside the United States. In fact, the Treasury Regulations specify that qualified export receipts of an IC-DISC include gross receipts from architectural or engineering services for construction projects located, or proposed for location, outside the United States, whether such services are performed within the United States or elsewhere.
An IC-DISC is a separate corporation established by an AE firm or its owners. This separate corporation must make an election with the IRS and pass various tests established by the IRS to be an IC-DISC. For example, at least 95 percent of the corporation’s gross receipts must be qualified export receipts and the corporation must maintain separate books and records. While adding an additional entity to some organizational structures may seem complicated, the IC-DISC does not have much of a practical impact on the way the AE firm conducts its business. In fact, an IC-DISC does not need to be concerned about the performance of any activities and does not need employees or office space.
The IC-DISC enters into a commission agreement with the AE firm. Under this commission agreement, the IC-DISC receives a commission from the AE firm on qualifying revenues. Current IRS regulations allow the IC-DISC to earn commission income totaling the greater of 50 percent of export profits or 4 percent of qualified export sales. The IC-DISC commission is a current deduction to the AE firm, but the IC-DISC is not subject to federal tax on its commission income. Instead, the shareholders of the IC-DISC are taxed on its income when it is distributed to the shareholders.
When distributed, the commission becomes qualified dividend income to the IC-DISC’s shareholders. This converts ordinary income (39.6 percent maximum tax rate) to qualified dividends (20 percent maximum tax rate) and can result in federal tax savings of almost 20 percent. The tax benefits are only applicable to commission income paid to the IC-DISC from the AE firm.
Design professionals providing architectural and engineering services on construction projects outside the United States may be able to take advantage of this tax incentive. It is, of course, important for design professionals planning to perform work in a foreign country to take into account all regulatory requirements, such as licensing and insurance, that govern the practice of architecture and engineering in that foreign country. We encourage interested parties to discuss this strategy with us and their other legal and financial advisors.