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- @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.
-
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-