The Interplay of Tax Reform’s IC-DISC & Pass-Through Deduction: What We Know So Far
September 26, 2018
A key tax benefit for companies that do exports was at risk of getting killed from President Donald J. Trump’s Tax Cuts and Jobs Act, but was saved by aggressive lobbying from pass-through companies, Forbes, Industry Week and others have reported.
Although the IC-DISC benefit is somewhat diminished because of lower overall income tax rates, the export incentive is still a valuable tool for domestic companies with sizable exports, especially when applied alongside the new section 199A of the tax code allows for a 20 percent deduction on pass-through income.
Companies that do exports can create a separate legal entity called an Interest-Charge Domestic International Sales Corporation (IC-DISC).
The parent company pays commissions to the DISC on exports, and business owners enjoy a reduced 20 percent capital gains tax rate on at least half of the income from qualifying exports.
“The power of the IC-DISC is still alive and well,” CPA Practice Advisor declared in a recent article.
The Benefit Spread
IC-DISC was introduced by Congress in its current form in the 1980s as an incentive to stimulate exports.
Before TCJAwas signed into law, IC-DISC shareholders had an effective 15.8 percent tax savings, which is the spread between the top marginal tax rate of 39.6 percent and the capital gains tax rate of 23.8 percent on the dividend distributions paid out by the IC-DISC.
Now that the highest marginal tax rate has been lowered to 37 percent and the capital gains rate is unchanged, the IC-DISC benefit spread is squeezed to 13.2 percent.
It’s still a sizable savings for qualifying businesses, the San Francisco Business Times has reported. Other key provisions of the IC-DISC program were also preserved, such as the entities being exempt from income tax.
Companies structured as pass-through entities such as limited liability companies (LLCs), S corporations, partnerships, trusts and certain other businesses can also take advantage of section 199A, which allows a pass-through deduction of 20 percent of qualified business income (QBI).
“While not as great as the tax advantage under the prior law, this reduction is considered to be significant and was heavily lobbied for by the flow-thru entity coalitions because of the additional DISC benefit,” law firm Baker McKenzie wrote in a client alert in January.
One vocal proponent for preserving IC-DISC was the $5 billion California almond industry, whose 1 million acres of almond trees provide the entire almond supply for North America and an estimated 80 percent of the world’s supply.
The Golden State’s almond industry accounts for 104,000 jobs and getting rid of IC-DISC would have been “crushing” for the industry, a major almond grower named Bill Lyons wrote in an open letter published in the Sacramento Bee last November as the House and Senate were trying to agree on the legislation.
“The IC-DISC enables the industry to be a valued solution toward addressing our nation’s trade deficit with other countries,” Lyons wrote. “Preserving this export tax tool is make-or-break.”
When the measure was preserved, the CEO of Blue Diamond Growers, a major almond producer, took a victory lap in a letter to co-operative members.
“Our congressional leaders reported that our growers were clear on the impact of losing these deductions in their calls and letters. We were also told that Blue Diamond’s co-op representatives provided the most detailed and convincing data on the negative impacts to growers,” Mark Jansen of Blue Diamond wrote to members.
Another industry that relies heavily on IC-DISC is California’s cotton industry.
IC-DISC is a “critical tool” and losing it would have cost millions of dollars, the California Cotton Ginners & Growers Association (CCGGA) said in a note to members late last year when it was on the chopping block in a Senate version of the tax bill.
Members made daily calls to leaders in Washington, D.C., and New York City to plead their case for saving IC-DISC.
“It was the specific examples of the impact of potentially losing IC-DISC that changed the tide for us,” the CCGGA told members in a congratulatory note after the provision was restored.
The IC-DISC benefit, which allows the lower qualified dividend tax rate for certain income from exports, was on the chopping block in early versions of the tax reform law, and was preserved in the final version that was signed into law.
The lower headline tax rate diminishes the spread of the IC-DISC benefit, although it is still valuable for companies with significant exports profits.
Certain companies organized as pass-through entities can also take advantage of a new 20 percent pass-through deduction of qualifying income under changes to section 199A of the Tax Cuts and Jobs Act (TCJA).