The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Is It Time for an IC-DISC
Dec 11, 2013
Many farmers or groups of farmers are starting to earn a greater percentage of their income from sale of products directly for exports. If this applies to your farm operation and the amount of foreign exports is greater than $1 million, then you should consider forming an interest charge - domestic international sales corporation (IC-DISC). This is not a type of Frisbee, but a very efficient way of permanently reducing your income tax burden, assuming you meet the criteria.
Essentially, the IC-DISC is a C corporation that earns a commission from your farm operation related to your foreign sales. The amount of commission is the greater of 1) 4% of your farm's gross receipts from qualified exports, or 2) 50% of your farm's net income from qualified exports. Usually most companies use #1 since it is much easier to compute.
The commission paid to the IC-DISC by your farm is deductible, whereas the commission earned by the IC-DISC is non-taxable. This almost sounds too good to be true and there is one more catch. If you leave the money in the IC-DISC it is tax-free, however, most farmers want their money. Therefore, when the funds are paid from the IC-DISC to the farmer, it is treated as a dividend. If you are in the highest tax bracket, this will be taxed at most likely 23.8%.
However, the permanent tax benefit relates to your farm operation being in the highest income tax rate of 39.6% and the dividend only being taxed at 23.8%. Let's look at a couple of examples:
Farmer Bean sells non-GMO beans to Japan. His direct foreign sales average about $4 million each year and he is in the highest individual tax bracket. He creates an IC-DISC and during the year pays a commission of $160,000 to the IC-DISC. He deducts this commission on his tax return saving $63,360. However, he also pays out a dividend of $160,000 that is taxed at 23.8% or $38,080. He has permanently saved $25,280 (his tax savings maybe even higher if he is self-employed). His cost for preparing the tax return and the related paperwork should be less than $5,000 each year.
Let's assume that Farmer Bean is in a lower tax bracket and normally has about $125,000 of net farm income to be reported each year. This results in him paying about $30,000 a year of self-employment and income taxes. If he forms the IC-DISC and let's assume the IC-DISC commission is exactly $125,000. This results in his Schedule F income now be zero, however, he has a dividend of $125,000. Dividend income in lower tax brackets is taxed as zero. If Farmer Bean is married, it is likely that about $100,000 of this dividend would be taxed at zero and the remainder at 15% or about $4,000 of income tax. Even though Farmer Bean is in a lower tax bracket, he ends up saving about $25,000 which is about the same as being in a high income tax bracket.
To set up an IC-DISC requires someone who is qualified to set these up and help you manage them. Once they are created, in many cases, there will only be about five or so transactions a year that flow through them. The commission coming in, the dividends going out and the administration fees to prepare the tax return and related services.
If you have large foreign sales, make sure to discuss an IC-DISC with your tax advisor.