IRS issues blueprint for IC-DISC audits.

• Author: Richardson, Douglas
• Position: Interest charge domestic international sales corporations

On March 12, the IRS released its advanced audit guide (LB&I-04-0212-003, available at tinyurl.com/d2mvxm7) for agents involved in examinations of interest charge domestic international sales corporations (IC-DISCs). IC-DISCs' goal remains the same as when they were originally enacted in the early 1970s: to stimulate U.S. exports and motivate U.S. manufacturers to produce products domestically.

Prior to the reduction in the individual tax rates on qualified dividends in 2003 and the repeal of the extraterritorial income exclusion regimes in 2004, the IRS received a relatively small number of Forms 1120-IC-DISC, Interest Charge Domestic International Sales Corporation Return. Since then, the number of IC-DISC returns has increased significantly; in 2008 approximately 2,000 IC-DISC returns were filed. The IRS expects this number to continue to grow in future years, especially if the qualified dividend rates remain significantly lower than ordinary income rates.

Given its increasing use, the IC-DISC is now on the IRS radar screen, and the newly released audit guide gives IRS examiners a step-by-step procedure on how to audit these companies. The guide educates the examiners on the relevant Code sections, related regulations, and cases regarding IC-DISCs. Although an IRS audit guide cannot be cited as the basis for an adjustment, it does provide agents with the materials that can be cited and gives them a starting point for their audits as well as issues to red flag. Understanding what IRS examiners are looking for can help practitioners and their clients avoid surprises.

An IC-DISC is a domestic corporation that, under Sec. 991, is not subject to income tax. These corporations are now the only export tax incentive within the Code. One benefit that makes an IC-DISC attractive is its ability to defer income tax on export profits. Perhaps the most attractive benefit of the IC-DISC is that the owner of the IC-DISC is eligible for the lower qualified dividend tax rate on distributions (currently a top rate of 15%, which is set to expire after Dec. 31, 2012, and increase to as high as 43.4%).

To qualify as an IC-DISC, the taxpayer must meet the strict requirements of Sec. 992. The primary qualifications are:

1. 9 5% or more of the corporation's gross receipts must be qualified export receipts. This test is performed annually, as described in Regs. Sec. 1.993-1.

2. The adjusted basis of the qualified export assets must be at least 95% of the sum of the...