Tax Planning for California Exports: IC-DISCs

California manufacturing exports are booming. In November 2013, California shipped merchandise worth $15.2 billion, a 14% jump over November 2012, more than twice the national rate for US exports (5.9%). 2013 was the best year since 2007.

For those California manufacturers who use a special type of US Corporation known as an IC-DISC, the DISC owner may, through sophisticated tax planning, receive significant tax benefits.

California manufacturers who receive 50% of their net income from foreign sales (e.g. on $10 million in sales, net income $5 million, 50% of net income = $2.5 million) may be subject to a significantly reduced US income tax rate.

1. DISC income tax rate is fixed at approximately 50% less tax rate (i.e. 20% not 39.6%).

2. Up to $2.5 million of the annual net export income (or in some cases a greater amount) may be subject to indefinite annual income tax deferral, by paying a 16 basis point interest charge (i.e. less than 1%). The deferred income must be “loaned back” to the manufacturer which effectively becomes (almost) “tax-free” annual financing of $2.5 million per year.

3. Under tax planning strategy developed with my colleague Ryan Losi, CPA (PIASCIK) who is a national “IC-DISC expert,” the annual $2.5 net export income (or greater) may be income tax free (see our article, “Tax Planning for US Exports: IC-DISC“).

In addition, the California manufacturer gets an immediate federal income tax deduction for their payment to the DISC, which may be $1 million+ (e.g. maximum federal income tax rate 39.6%), for pass-through payments to S-Corp, LLC plus 3.8% Medicare Tax on net investment income, and additional 3-4% tax for phase-outs of personal exemptions, itemized deductions.

So if the tax planning strategy is effective a double tax benefit based on $2.5 million in net export income, paid to the DISC as a sales commission (up to $1 million+ in immediate tax savings), deferred tax or no tax at all on the $2.5 million received by the DISC.

For Sept-Nov 2013 California’s biggest export markets:

1. Mexico $6.25 billion

2. Canada $5.21 billion

3. China $4.08 billion

4. Japan $3.34 billion

5. Hong Kong $2.32 billion

California manufacturing exports for 11 months in 2013 (Jan – Nov) was $153.5 billion, well ahead of 12 months total for 2012 ($148 billion), which was characterized by Jack O’Connell, trade specialist: “Unusually Huge Export Growth.”

For more information see LA Times article, “California exports jump to pre-recession levels.”

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