Small
Business Exporters (SBEs) Eligible for Tax Incentives
by
William H. Green, Managing Director, FDTA/CITE, White Plains, NY
Many small business exporters are leaving money behind by not claiming
the extraterritorial income exclusion (EIE) for eligible profits after 2000.
That’s when Congress approved new legislation repealing the Foreign
Sales Corporation (FSC) system of tax exemption and replacing it with the new
EIE system of tax exclusion. Unlike
an IRA or 401(k) that defers income tax, the exclusion allows nearly all small
business exporters a permanent reduction in tax. One of the biggest obstacles to exporters claiming the
exclusion, however, is not that the new law is too complex, but that they are
not aware of the legislation.
New Exclusion Permits Significant Tax Savings
for More Exporters
Under the new EIE legislation, small business exporters (SBEs) have the
opportunity to receive a 15-30% exemption from U.S. tax for qualified sales and
services. Estimated U.S. tax savings are $5 per thousand of export
sales, assuming a 10% pre-tax profit on qualified income. For example, if you earn a profit of 10% on $3 million in
export sales, your Federal tax savings are estimated at $1,500 ($5 x 300). This
tax savings results in lower taxes and more cash flow for export activities.
More
SBEs are intended to receive EIE tax savings than under the old FSC legislation.
Unlike the FSC, SBEs now include shareholders in C and S corporations,
members of LLCs, partners in U.S. partnerships and sole distributors.
The new legislation also includes special provisions for a shared
partnership vehicle, which allows separate SBEs to economize and share the costs
of export promotion and marketing, including trade shows.
1)
First, the exclusion of extraterritorial, or qualified income is
2)
Second, EIE tax benefits are simple to claim and do not require the
An important similarity in the EIE and FSC rules is the annual foreign
direct cost requirement. For SBEs
with more than $5 million in export sales, specified costs related to foreign
sales and marketing activities must be incurred outside the United States.
Most exporters can satisfy these tests directly or through agents located
offshore. For SBEs with sales under
$5 million, the foreign direct cost test is waived.
Many exporters may decide to only report their “best” $5 million in
qualified sales each year to avoid the foreign direct cost requirement.
Simple IRS Filing Requirements for Claiming EIE
Tax Savings
The
IRS has made it simple to claim EIE tax benefits. Every U.S. taxpayer -
individual or company - subject to U.S. tax can claim EIE benefits.
All you have to do is file a Form (Form 8873) with your personal or
business tax return. Since EIE benefits are automatic, exporters receive the
exclusion, whether or not they have identified or accounted for it in their
books and records. For pass-through entities, like LLCs, S corporations and
partnerships, the qualified export sales and sales activities are maintained at
the entity level. This data must be
reported separately for each member that claims the EIE on his or her personal
return.
The IRS Form 8873 also can be used to file for a refund of taxes under
the EIE rules. The EIE legislation is effective from October 1, 2000.
Under the FSC law, in an election was not filed, no tax benefits were
available. Since the EIE rules
apply by operation of law, if an exporter has not claimed EIE benefits yet, a
Form 8873 can be filed for earlier tax years without penalty or interest.
These refund claims will generate additional cash flow.
Identifying Export Sales and Services Eligible
for EIE Tax Benefits
An
export sale by a manufacturer or distributor is eligible for EIE tax savings
only if the goods sold consist of foreign trade property, which must consist of
at least 50% U.S. content. Foreign
trade property can be manufactured or produced in the United States or overseas
but must be sold for use or consumption outside the United States.
Only products grown or extracted in the United States, however, will
qualify as foreign trade property.
Unlike
the FSC rules, SBEs may conduct final assembly or processing of foreign trade
property in a foreign trade or export processing zone or under local
manufacturing or assembly tax holidays. For
example, a SBE may ship U.S. components to a free trade zone or assembly plant
in Costa Rica or Ireland for final assembly, provided the products are used or
consumed outside the United States. Companies
operating a maquilladoro in Mexico also can benefit under the new EIE
provisions.
Construction
and engineering services, including feasibility studies, related to a foreign
construction project also are eligible for EIE benefits, whether the services
are performed in the United States or overseas. Installation and maintenance services directly related to
export sales also qualify for EIE benefits, even if they do not generate a
profit. Banking, financial,
advertising and consulting services do not qualify, since there is only an
indirect connection to sales of foreign trade property.
The sale or licensing of software is eligible for EIE benefits, as well
as income from leases of foreign trade property.
How to Find Out More About the Extraterritorial
Income Exclusion
Many
SBEs are not aware of the EIE tax savings.
More and more small and medium-sized accounting and law firms, however,
learning the IRS rules and are available to discuss how your company can claim
EIE benefits in 2001 and 2002.
The
rules for identifying qualified sales and services can be complex.
It is important, therefore, that eligible SBEs find someone familiar with
the IRS guidelines in preparing the new IRS Form 8873.
Attending one of the live or videotaped FDTA conferences on the
Extraterritorial Income Exclusion will be helpful in identifying all qualified
sales and maximizing the tax savings under the EIE rules.
For more information, visit our website at www.fdta-cite.org.