As stated previously, the IC-DISC has versatility of use but can also be complicated. Depending on your purpose for incorporating a DISC entity, engaging in a producer’s loan may or may not make sense. First, let’s start by noting that a producer’s loan has numerous steps and tests, and frankly, is administratively heavy. However, for those willing, it can prove to be beneficial—if properly maintained.
When a Producer’s Loan is Appropriate
The purpose of a producer’s loan is to provide a deferral of taxes for the shareholder of the DISC and allow the related supplier to use the money in the meantime. Given the preferential capital gains taxation rate as compared to the ordinary business income rate, many flow-through companies do not see any benefit in utilizing this loan. The benefit is apparent for C-corporations that directly own an IC-DISC entity though. Since a C-corp does not receive dividends at a lower rate, a producer’s loan can provide an alternative benefit for the corporation.
The other instance in which this loan is beneficial is when a shareholder does not want to immediately incur taxes on the dividends from the DISC. For example, if the owner of the related supplier and IC-DISC wishes to defer the tax due on commissions for any given year, the DISC can loan the income to the related supplier; thus, the dividend is not being distributed to the owner at that point. The distribution to said shareholder must occur within the next five years though.
Implementing a Producer’s Loan
Now, for an overview of the implementation of a producer’s loan. Be forewarned, failure to meet the outlined requirements will disqualify the producer’s loan as a qualified asset, which in turn jeopardizes the DISC’s standing and can lead to a loss of the benefit entirely. A loan will be considered a producer’s loan if the loan, evidenced by an obligation, is made from accumulated DISC income to a qualified borrower and deemed as a producer’s loan at the time. The loan is limited to export related assets, which includes research and experimental expenditures as well as plant and equipment assets. Additionally, a test to prove an increase in research and experimental expenditures as well as several other asset classes must also be conducted. Lastly, an arm’s length interest charge applies and proof of compliance must be maintained.
If you are considering a producer’s loan, make sure to study the rules for making the loan and be educated on how a DISC retains its identity as such. Furthermore, consider the deemed dividend threshold of $10 million each year and how this affects deferring distributions. We also highly recommend consulting with an experienced provider for more information on as well as implementation of the loan.