IC – DISC must meet three conditions to receive income from a sale of export property:
- The property must be manufactured, produced, grown or extracted in the United States by a person other than IC-DISC.
- The export property must be held primarily for sale, lease or rental for direct use, consumption or disposition outside the U.S.
- The export property must have a minimum of 50% U.S content.
Manufacturing Requirements
Property has to be manufactured in the United States by a U.S person other than the IC-DISC.
Property is considered to be manufactured in the United States if:
- 20 percent of its conversion costs are incurred in the United States.
- There is a substantial transformation in the United States.
- The operations in the United States ae generally considered to constitute manufacturing.
The Destination Test
The export property must satisfy a destination test, which means it must be held for sale, lease or rental in the ordinary course of business for direct use, disposition or consumption outside the United States.
- Destination test is satisfied if the property is delivered to a freight forwarder for ultimate shipment abroad.
- Destination test is also met if the property is sold in the United States, provided it does not undergo further manufacturing or use by the purchaser prior to export, and property is shipped overseas within one year.
- No more than 50% of the fair market value of export property may be attributable to the fair market value of articles imported into the United States.
Determining the IC-DISC Benefit
The income of an IC-DISC from sale of export property is in an amount constituting:
- 4 percent of qualified export receipts.
- 50percent of the combined taxable income from qualified export receipts, or
- The arm’s length amount determined under the transfer pricing principles of section 482.
Maximizing the IC-DISC Income
- The IC-DISC rules permit the use of different methods to different sales based on product lines, recognized industry or trade usage, and even by transaction.
- As a simple rule of thumb, the combined taxable income method results in the largest IC-DISC income when exports have a net pre-tax margin of 8.7 percent or greater.
- On the other hand, the qualified export receipts method provides the largest IC-DISC income when the net pre-tax margin is lea than 8.7 percent.
Domestic Production Deduction
The domestic production deduction equals 9% of the lesser of taxable income or qualified production activities income of the taxpayer.
In determining the amount of the deduction, a taxpayer must analyze the following:
- Domestic production gross receipts.
- Costs allocated to domestic production gross receipts.
- Total wages on forms W-2.
Domestic production gross receipts are generally any sale, exchange, or other disposition of qualifying production property (including, inter alia, tangible personal property) that is manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part with in the United States.
After determining domestic production gross receipts, the taxpayer arrives at qualified production activities income by subtracting allocable costs, the cost of goods sold deduction and other deductions allocable to these receipts.
The deduction is limited to 50% of the W-2 wages related to the taxpayer’s domestic production gross receipts. The policy behind trying the maximum deduction to an amount based on W-2 wages is to increase W-2 wages, which presumable are paid to employees in manufacturing jobs.
References:
Practical Guide to US Taxation of International transactions 9th Edition
Robert J. Misey Jr.
Michael S. Schadewald
Publishers: Wolter Kluwer, CCH Incorporated.