Thursday, May 3, 2012

Will 2012 be the Last Year for the Last Tax Incentive Available to Exporters of Manufactured Goods and Software?

The expiration of the Bush/Obama tax cuts is now part of our national conversation. Politicians are jockeying for political leverage in the face of both the upcoming presidential election and the expiration of the Bush/Obama tax cuts at the end of 2012. One of the hot items right now is the current tax rate of 15% for long term capital gains rates, which oddly enough, is the primary driver for the best and last available tax incentive available to exporters of US made products and software.

The current Federal tax system allows international exporters to take advantage of an Interest Charge Domestic International Sales Corporation (DISC). By using a DISC, a portion of the international export income can be taxed at the favorable long term capital gains rate of 15% as opposed to ordinary income rates that may be as high as 35% for individuals. The average manufacturer with $5 million in international sales and a 20% profit margin can reduce their Federal tax liability by approximately $100,000. The DISC tax incentive can be utilized by closely held businesses with $1 million to $100 million of export revenue.

In order to qualify for DISC benefits the following three components must be present in the exported goods or software:

1.    The product being sold must be manufactured, produced, grown or extracted in the United States by a person (person meaning the exporting company) other than the DISC.

2.    The end use of the property must be outside of the United States.

3.    The product must not include imported raw materials that account for more than 50% of the final sales price.

The DISC is invisible for most purposes except for tax filings. The DISC has no economic substance and does not require any change in operations for the export company.

DISC’s are also available for companies that buy US manufactured products and resell those products internationally and architects and engineers with international projects. Additionally, a DISC can also be owned by a ROTH IRA or trusts for the business owner’s children.

Will the DISC be useful post 2012?

A DISC will provide a reduced tax liability as long as there is a spread between the highest ordinary income tax rate and the long term capital gains rate. If the Bush/Obama tax cuts expire the maximum individual tax rates will increase to 39.5%. If the “Buffet Rule” is enacted, the long term capital rate will most likely increase to 30%. At the 39.5% rate for ordinary income and 30% rate for capital gain income a DISC will reduce the tax rate by 9.5% instead of the current 20%. At 9.5%, the DISC will still be a powerful tax tool, but the revenue required to make a DISC start to make sense will increase to $2 million in export sales.

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Joe Bishop is a Certified Public Accountant at Nasif, Hicks, Harris and Co., LLP. Joe can be reached via phone at (805) 979-9383, email at JBishop@nhhco.com, or Linkedin at http://www.linkedin.com/in/joebishopcpa.

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