Cream of the Crop 1/Cream of the Crop 1.iso/BUSINESS/SBA62.ARJ/FSBA.EXE/F237.SBE

Text File | 1992-04-30 | 6KB | 107 lines

@104 CHAP 8

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          │DOMESTIC INTERNATIONAL SALES CORPORATIONS (DISC)│
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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 sub-
sidy by setting up a Domestic International Sales Corporation (DISC).
In general, a DISC will allow you to accumulate profits earned from ex-
port 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 mil-
lion 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 em-
ployees, 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, in-
curred 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 com-
mission.

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 ac-
cumulated 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 down to less than 5% as of late 1991).

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

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

Hawaii follows the federal tax treatment of DISCs, including the fed-
eral 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.