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Text File | 1996-11-06 | 6KB | 125 lines

@104 CHAP 8

       ┌────────────────────────────────────────────────┐
       │DOMESTIC INTERNATIONAL SALES CORPORATIONS (DISC)│
       └────────────────────────────────────────────────┘

If your business is one of the many small U.S. firms that
sells goods or services overseas, you may be able to
qualify for a tax export subsidy by setting up a Domestic
International Sales Corporation (DISC).  In general, a
DISC will allow you to accumulate profits earned from
export sales in a specially-treated corporation that does
not pay tax on those profits.  Tax on these export profits
is deferred until the DISC pays out (if ever) such profits
to its owners.  In the meantime, it is possible for the
DISC to, in effect, lend the funds back to its related
supplier company.

Note that since the Tax Reform Act of 1984, DISCs have been
obsolete for larger companies, since DISC gross receipts in
excess of $10 million are fully taxable since 1985.  However,
for small exporters, DISCs may be preferable (as well as
much simpler to set up and operate) than the new "Foreign
Sales Corporations" (FSCs) that have largely replaced them,
at least for the first few years of operation.  Also,
interest must now be paid to the IRS on the tax liability
that has been deferred as a result of the existence of the
DISC tax deferrals.

A DISC is essentially just a "dummy" corporation that has
no employees and does not carry on any sort of business,
except on paper.  The tax law allows a U.S. company that
has "qualified export receipts" to set aside part of its
profits on the export transactions by paying a so-called
sales commission to a DISC.  As a corporation without any
employees, the DISC does not actually do anything to earn
the commission; your firm merely pays the DISC the largest
commission permitted by the tax law on each qualifying
export sale it makes.  (It is usually advisable to have a
written commission agreement between your firm and the DISC
for legal purposes, although not required for tax purposes.)

The commission that can be paid to the DISC on an export
sale is the larger of 4% of the gross sales price on an
export sale or 50% of the profit on the sale (so long as
the commission does not create a loss on the sale for your
firm).  In addition, the DISC's commission income can be
increased by 10% of certain export promotion expenses, if
any, incurred by the DISC.  As you might have guessed,
there are some rather elaborate tax accounting rules which
determine how much profit you have on an export sale, for
purposes of computing the DISC's maximum commission.

The tax benefits for your business arise from the fact
that you or your business owns the DISC stock, and the
commissions your business pays to the DISC are deducted
from the business's taxable income, while the DISC pays
no tax on income it receives.

However, about 6% (1/17th) of the DISC's income each year
is taxed to its corporate (but not individual) shareholders,
so the DISC should usually pay about 6% of its income
back as a dividend to the business that owns the stock of
the DISC (which is usually, but not necessarily, your
corporation that paid the DISC the commissions).  Thus,
16/17, or about 94% of the income that is shifted to the
DISC as export sales commissions escapes federal income tax
indefinitely, until the DISC either pays out the accumulated
income as dividends or is disqualified and loses its status
as a DISC.  For deferred DISC income that has accumulated
after 1984, each DISC shareholder must compute the amount
of additional tax it would pay each year if all the deferred
DISC income were taxed and pay the IRS interest on the
deferred tax.  This interest should usually be tax-deductible
if paid by a corporation.  The interest rate is based on the
going rate for 1-year T-bills, which is usually a quite
favorable (that is, low) rate.

Conceptually, having a DISC can be thought of as taking
$100 out of your left-hand pocket and putting it in your
right-hand pocket, and taking a $100 deduction.  However,
you have to put back $6 of the $100 into your left-hand
pocket and report it as income, so it's really only a net
deduction of $94.  You do not have to pay tax on the $94
that remains in your right-hand pocket as long as you leave
it there.  In fact, there are even legal ways in which you
can borrow the $94 and put it back in the left-hand pocket
(your business!) without paying tax on it, thus having your
cake and eating it, too.  The only fly in the ointment is
that as long as you keep deferring tax on the $94, you must
pay interest to the IRS on the tax deferred (but at a low
interest rate--equal to the average interest rate on
one-year Treasury bills, which were at about 5% as of
1996).

An interesting tax planning wrinkle if you set up a DISC is
to put some or all of the stock of the DISC in the hands of
your children.  Once they are 14 years old (if under 14,
their income gets taxed at your marginal tax rate), part of
the deferred income in the DISC can be paid out as dividends
and taxed to the children in their low tax brackets.  Thus,
in effect, you business could "skim" off part of its profits
by paying commissions to the DISC which would then be taxed
at a low rate to your children when distributed as dividends.
This would almost be like paying tax-deductible dividends
out of your incorporated business to your children, a very
nice bit of tax planning (and your business doesn't even
have to be incorporated, only the DISC does).

@CODE: HI

        ┌───────────────────────────────────────────────┐
        │    HAWAII TAX TREATMENT OF DISC'S AND FSC'S   │
        └───────────────────────────────────────────────┘

Hawaii follows the federal tax treatment of DISCs, including
the federal provisions regarding interest charge DISCs,
provided that the DISC is organized in Hawaii and has its
principal place of business in the state of Hawaii.  However,
Hawaii has NOT adopted the federal Foreign Sales Corporation
(FSC) provisions that provide special federal tax treatment
to FSCs and their shareholders.