Why Should I Set up a DISC?

 A “DISC” is a domestic international sales corporation.  A DISC can be used to lower the overall effective income tax rate a company pays on its income derived from export sales.   Under federal income tax law, a company which manufactures a product in the United States, and exports the product outside the United States, can pay a tax-deductible royalty to a DISC in an amount equal to the greater of 4% of export sales or 50% of export income.  The DISC itself pays no federal income tax on the royalty payments it receives.  Rather the royalty payments received by the DISC are taxable to the DISC shareholders at a 15% rate when distributed as qualified dividends.  This means the effective overall federal income tax rate on the company's export income has been decreased by  20% or more.  This income tax savings can be even greater if the DISC is established in a state like Nevada or Florida which does not have a state income tax.

To set-up a DISC, it is necessary to incorporate a the DISC as a corporation with stated capital of $2,500.  The DISC can be a subsidiary of the operating company or a brother-sister affiliate of the operating company.  In a brother-sister affiliate situation, the owners of the DISC are usually, but not always, the same as the owners of the operating company. 

The DISC enters into a royalty agreement with the operating company whereby the operating company agrees to pay the DISC a royalty in an amount no more than 4% of export sales or 50% of export income (the maximum allowed under the federal income tax law).  The DISC does not need to have employees or actually conduct its own independent operations.  It is important however to be able to prove the amount of export sales and export income.  For this purpose it is important to properly allocate expenses and overhead between the operating company’s domestic and international sales operations. 

There has been some talk over the last few years about eliminating the favorable tax treatment afforded DISCs.  But at this point, no legislation to remove the DISC advantage is imminent.  The favorable DISC treatment is a powerful incentive for domestic companies to sell abroad.  Given the current trade imbalance, it seems unlikely that Congress would act to eliminate this export incentive. If you are interested in knowing more about how a DISC works or setting up a DISC, give me a call.  

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AND ONE MORE THING.  Many businesses have been improperly classifying employees as independent contractors.  The reason?  Classifying workers as contractors rather than employees can save an employer 20-30% of its overall labor costs.  Now in a surprising move, the IRS has announced a new program that will allow businesses to reclassify their workers as employees, and pay only a small amount to cover past payroll taxes.  However, the IRS has also announced plans to aggressively audit and look for worker misclassification in the future.  Give me a call if you have any questions about whether your workers can or should be treated as employees or independent contractors.  Jsenney@pselaw.com or 937-223-1130.

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