Tax Benefits for Profitable Construction Contracts Overseas

by Kevin O'Connell, CPA, JD

While IC-DISC sounds like a high-tech frisbee or a cold summer drink, it's an acronym for what is actually a significant export incentive for U.S. companies that sell goods and services outside of the U.S. (IC-DISC=Interest-Charge Domestic International Sales Corporation). Taxpayers taking advantage of the IC-DISC are typically small to mid-size companies with annual gross revenues that range from $5 million to over $250 million. These exporters represent a range of industries including—manufacturers, distributors, architectural and engineering firms, software developers and farmers. The IC-DISC is one of the last remaining export incentives enacted by Congress to encourage exports.

Who Is a Candidate?

A taxpayer that has a profitable engineering or architectural construction contract overseas, and the taxpayer that performs the service is a flow-through entity like an S corporation, a partnership or a sole proprietorship. The idea applies equally to exporters of tangible personal property.

Why Now?

The IC-DISC idea was injected with new life because Congress retained the Bush tax cuts by limiting the top tax rate to 15% on dividends received from qualified C corporations. This tax rate was extended through December 31, 2012.

How Does It Work?

The IC-DISC converts ordinary income from services rendered to dividend income from services rendered. The IC-DISC reduces the top federal income tax rate on export profits from 35% to 15%.

The taxpayer must first form an IC-DISC entity. The setup will require knowledge of the election forms to file. Second, the DISC must earn revenue in the form of a commission. The commission rate is fixed by statute. For example, an architect forms and IC-DISC and deducts the commission paid. The federal tax benefit of the deduction will be based on the architect’s top marginal tax rate, which is generally between 25% and 35%. Third, the IC-DISC reports the commission income on its tax return. The commission income is exempt from federal tax and likely state income tax. Fourth, the IC-DISC pays a dividend to its shareholder(s) in the same year it received the commission income. For example, the shareholder of the IC-DISC, who is also the architect that performed the service, pays federal tax on the qualified dividend at a tax rate up to 15%.

Taxpayers must form the IC-DISC before they begin the work that qualifies for the commission. For taxpayers that plan to provide engineering or architectural services for overseas construction contracts, and expect a profit, it may make sense to form the IC-DISC and then decide at the end of the taxable year whether or not to use it. If the engineer or architect loses money on the overseas project, he or she can forgo paying the commission.

Somerset Can Help

Somerset professionals have experience helping our clients take advantage of this tax benefit. If you would like to consider implementing an IC-DISC, please contact us.