IRA-owned FSCs.

• Author: Granberg, Michael W.
• Position: Foreign sales corporations; taxation

The use of foreign sales corporations (FSCs) can result in significant income tax savings to manufacturers and distributors with income from export sales. The tax savings is in the form of a permanent tax reduction on a portion of the earnings from export sales. The reduction is based on a stated percentage (15/23 for corporate-owned FSCs, 16/23 for all others) of the FSC's earnings, computed using allowable administrative pricing rules. Dividends paid by a FSC to a C shareholder can be offset completely by the dividends-received deduction (DRD). Therefore, a FSC can reduce the tax paid on earnings from foreign exports by 15/23 of the earnings determined to be earned by the FSC.

Historically, FSCs have been considered feasible only in a C corporation environment; only C corporations can claim a DRD for dividends from an FSC. Likewise, FSCs are normally created under the ownership of a related supplier. There are, however, alternatives for the ownership of FSCs that might increase their effectiveness. In addition, the use of an interest-charge domestic international sales corporation might also be considered under certain circumstances.

Individual retirement account (IRA)-owned FSCs can provide significant tax benefits, particularly in an S environment. Because S corporations are not allowed a DRD, an FSC owned by a related S corporation supplier provides no benefit; in fact, the result is a slightly higher effective tax rate. An FSC owned directly by the shareholders will yield no tax benefit, for the same reason. However, an IRA-owned FSC can be used to receive tax-free distributions from the FSC. A second benefit is that the dividends from the FSC can be reinvested tax-free and remain tax-free until distributed from the IRA. Exhibit 1 illustrates the potential tax benefit of an IRA-owned FSC in an S environment.

Exhibit 1: FSC Potential Tax Benefits No FSC FSC owned by S corporation and/or shareholders Tax on S shareholders: 1. Export profits $100.00 $100.00 2. FSC commission (23.00) 3. Taxable income 100.00 77.00 4. Tax at 39.5% 39.50 30.42 Tax on FSC: 1. Income 23.00 23.00 2. Exemption (16/23) (16.00) 3. Taxable income 7.00 7.00 4. Tax at 34% 2.38 2.38 Tax on FSC dividends: 1. After-tax FSC income 20.62 2. Tax at 39.5% 8.14 Total tax liability 39.50 40.94 Tax on reinvested profits 39.5% 39.5% FSC owned by IRA or plan Tax on S shareholders: 1. Export profits $100.00 2. FSC commission (23.00) 3. Taxable income 77.00 4. Tax at 39.5% 30.42...