Penalties

The IC-DISC may have to pay the following penalties unless it can show that it had reasonable cause for not providing information or not filing a return:

• $100 for each instance of not providing required information, up to $25,000 during the calendar year.
• $1,000 for not filing a return.

If the return is filed late and the failure to file timely is due to reasonable cause, please explain. See section 6686 for other details.

Trust fund recovery penalty. This penalty may apply if certain income, social security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 941 or 945. The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, and paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See Pub. 15 (Circular E), Employer's Tax Guide, for details, including the definition of responsible persons.

Specific Instructions

Period Covered

File the 2001 return for calendar year 2001 and fiscal years that begin in 2001 and end in 2002. For a fiscal year return, fill in the tax year space at the top of the form.

Note: The 2001 Form 1120-IC-DISC may also be used if :

• The corporation has a tax year of less than 12 months that begins and ends in 2002 and
• The 2002 Form 1120-IC-DISC is not available at the time the corporation is required to file its return.

The corporation must show its 2002 tax year on the 2001 Form 1120-IC-DISC and take into account any tax law changes that are effective for tax years beginning after December 31, 2001.

Address

Include the suite, room, or other unit number after the street address. If the Post Office does not deliver mail to the street address and the corporation has a P.O. box, show the box number instead.

Item C - Employer Identification Number (EIN)

Enter the corporation's EIN. If the corporation does not have an EIN, it must apply for one on Form SS-4, Application for Employer Identification Number. If the corporation has not received its EIN by the time the return is due, write Applied for in the space for the EIN. See Pub. 583, Starting a Business and Keeping Records, for details.

Item E - Total Assets

Enter the IC-DISC's total assets (as determined by the accounting method regularly used in keeping the IC-DISC's books and records) at the end of the tax year. If there are no assets at the end of the tax year, enter the assets as of the beginning of the tax year.

Item F - Initial Return, Final Return, Name Change, Address Change, or Amended Return

• If this is the IC-DISC's initial or final return, check the applicable box in item F at the top of the form.
• If the IC-DISC has changed its address since it last filed a return, check the box for Address Change.

  Note: If a change in address occurs after the return is filed, use Form 8822, Change of Address, to notify the IRS of the new address.

• If the IC-DISC changed its name since it last filed a return, check the box for Name change. Generally, an IC-DISC also must have amended its articles of incorporation and filed the amendment with the jurisdiction in which it was incorporated.
• To correct an error on a Form 1120-IC-DISC already filed, file an amended Form 1120-IC-DISC and check the Amended return box. If the amended return changes the income or distributions of income to shareholders, an amended Schedule K (Form 1120-IC-DISC) must be filed with the amended Form 1120-IC-DISC and given to each shareholder. Write AMENDED across the top of the corrected Schedule K you give to each shareholder.

Question G(1)

For rules of stock attribution, see section 267(c). If the owner of the voting stock of the IC-DISC was an alien individual or a foreign corporation, partnership, trust, or estate, check the Yes box in the Foreign owner column and enter the name of the owner's country, in parentheses, in the address column. Owner's country for individuals is their country of residence; for other foreign entities, it is the country in which organized or otherwise created, or in which administered.

Taxable Income

An IC-DISC must figure its taxable income although it does not pay most taxes. An IC-DISC is exempt from the corporate income tax, alternative minimum tax, and accumulated earnings tax.

An IC-DISC and its shareholders are not entitled to the possessions corporation tax credit (section 936). An IC-DISC cannot claim the general business credit or the credit for fuel produced from a nonconventional source. In addition, these credits cannot be passed through to shareholders of the corporation.

Line 6a - Net Operating Loss Deduction

The net operating loss deduction is the amount of the net operating loss carryover and carryback that can be deducted in the tax year. See section 172 and Pub. 536, Net Operating Losses, for details.

A deficit in earnings and profits is chargeable in the following order:

1. First, to any earnings and profits other than accumulated IC-DISC income or previously taxed income.
2. Second, to any accumulated IC-DISC income.
3. Third, to previously taxed income.

Do not apply any deficit in earnings and profits against accumulated IC-DISC income that, as a result of the corporation's revoking its election to be treated as an IC-DISC (or other disqualification), is deemed distributed to the shareholders. See section 995(b)(2)(A).

Line 6b - Dividends-Received Deduction

See the instructions under Schedule C, Line 9, Column (c) on page 9 for details.

Line 7 - Taxable Income

If the IC-DISC uses either the gross receipts method or combined taxable income method to compute the IC-DISC's taxable income attributable to any transactions involving products or product lines, attach Schedule P (Form 1120-IC-DISC). Show in detail the IC-DISC's taxable income attributable to each such transaction or group of transactions.

Line 8 - Refundable Credit for Federal Tax Paid on Fuels

Enter the credit from Form 4136.

Schedule A

Cost of Goods Sold

Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an income-producing factor. See Regulations section 1.471-1.

However, if the IC-DISC is a qualifying taxpayer, it may adopt or change its accounting method to account for inventoriable items in the same manner as materials and supplies that are not incidental. A qualifying taxpayer is a taxpayer (a) whose average annual gross receipts for the 3 prior tax years is $1 million or less and (b) whose business is not a tax shelter (as defined in section 448(d)(3)). In addition, for tax years ending on or after December 31, 2001, this rule applies to an eligible business of a qualifying small business taxpayer. A qualifying small business taxpayer includes a corporation with average annual gross receipts of more than $1 million but less than or equal to $10 million and that is not prohibited from using the cash method under section 448. For more details, including the definition of an eligible business, see Notice 2001-76.

Under this accounting method, inventory costs for merchandise purchased for resale are deductible in the year the merchandise is sold (but not before the year the IC-DISC paid for the merchandise, if it is also using the cash method). Enter amounts paid for merchandise during the tax year on line 2. The amount the IC-DISC can deduct for the tax year is figured on line 8.

For additional guidance on this method of accounting for inventory items, see Rev. Proc. 2001-10 and Pub. 538, Accounting Periods and Methods.

All filers not using the cash method of accounting should see Section 263A uniform capitalization rules on page 10 before completing Schedule A.

If the IC-DISC uses intercompany pricing rules (for purchases from a related supplier), use the transfer price figured in Part II of Schedule P (Form 1120-IC-DISC).

If the IC-DISC acts as another person's commission agent on a sale, do not enter any amount in Schedule A for the sale. See Schedule P (Form 1120-IC-DISC).

Line 1

Inventory at Beginning of Year

If the IC-DISC is changing its method of accounting for the current tax year, it must refigure last year's closing inventory using the new method of accounting and enter the result on line 1. If there is a difference between last year's closing inventory and the refigured amount, attach an explanation and take it into account when figuring the IC-DISC's section 481(a) adjustment. See Accounting Methods on page 4.

Line 4

Additional Section 263A Costs

An entry is required on this line only for IC-DISCs that have elected a simplified method of accounting.

For IC-DISCs that have elected the simplified production method, additional section 263A costs are generally those costs, other than interest, that were not capitalized under the IC-DISC's method of accounting immediately prior to the effective date of section 263A but are now required to be capitalized under section 263A. For details, see Regulations section 1.263A-2(b).

For IC-DISCs that have elected the simplified resale method, additional section 263A costs are generally those costs incurred with respect to the following categories.

• Off-site storage or warehousing.
• Purchasing; handling, such as processing, assembling, repackaging, and transporting.
• General and administrative costs (mixed service costs).

For details, see Regulations section 1.263A-3(d).

Enter on line 4 the balance of section 263A costs paid or incurred during the tax year not includible on lines 2, 3, and 5.

Line 5

Other Costs

Enter on line 5 any costs paid or incurred during the tax year not entered on lines 2 through 4.

Line 7

Inventory at End of Year

See Regulations section 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory.

If the IC-DISC accounts for inventoriable items in the same manner as materials and supplies that are not incidental, enter on line 7 the portion of its raw materials and merchandise purchased for resale that are included on line 6 and were not sold during the year.

Lines 9a through 9f

Inventory Valuation Methods

Inventories can be valued at:

• Cost;
• Cost or market value (whichever is lower); or
• Any other method approved by the IRS that conforms to the requirements of the applicable regulations cited below.

However, if the IC-DISC is using the cash method of accounting, it is required to use cost.

IC-DISCs that account for inventoriable items in the same manner as materials and supplies that are not incidental may currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.

The average cost (rolling average) method of valuing inventories generally does not conform to the requirements of the regulations. See Rev. Rul. 71-234, 1971-1 C.B. 148.

IC-DISCs that use erroneous valuation methods must change to a method permitted for Federal income tax purposes. To make this change, use Form 3115.

On line 9a, check the method(s) used for valuing inventories. Under lower of cost or market, the term market (for normal goods) means the current bid price prevailing on the inventory valuation date for the particular merchandise in the volume usually purchased by the taxpayer. For a manufacturer, market applies to the basic elements of cost - raw materials, labor, and burden. If section 263A applies to the taxpayer, the basic elements of cost must reflect the current bid price of all direct costs and all indirect costs properly allocable to goods on hand at the inventory date.

Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal due to damage, imperfections, shopworn, etc., within the meaning of Regulations section 1.471-2(c). The goods may be valued at the current bona fide selling price, minus direct cost of disposition (but not less than scrap value) if such a price can be established.

If this is the first year the Last-in, First-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued under the LIFO method provided in section 472, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970. Also check the LIFO box on line 9c. On line 9d, enter the amount or the percent of total closing inventories covered under section 472. Estimates are acceptable.

If the IC-DISC changed or extended its inventory method to LIFO and had to write up the opening inventory to cost in the year of election, report the effect of the write-up as other income, proportionately over a 3-year period that begins with the year of the LIFO election (section 472(d)).

For more information on inventory valuation methods, see Pub. 538, Accounting Periods and Methods.

Schedule B

Gross Income

If an income item falls into two or more categories, report each part on the applicable line. For example, if interest income consists of qualified interest from a foreign international sales corporation and nonqualifying interest from a domestic obligation, enter the qualified interest on an attached schedule for line 2g and the nonqualifying interest on an attached schedule for line 3f.

For gain from selling qualified export assets, attach a separate schedule in addition to the forms required for lines 2h and 2i.

Accrual method taxpayers need not accrue certain amounts to be received from the performance of services that, on the basis of their experience, will not be collected (section 448(d)(5)). This provision does not apply to any amount if interest is required to be paid on the amount or if there is any penalty for failure to pay timely the amount. IC-DISCs that fall under this provision should attach a schedule showing: (a) total gross receipts, (b) the amount not accrued as a result of the application of section 448(d)(5), and (c) the net amount accrued. The net amount should be entered on the applicable line of Schedule B. For more information and guidelines on this non-accrual experience method, see Temporary Regulations section 1.448-2T.

Commissions: Special Rule

If the IC-DISC received commissions on selling or renting property or furnishing services, list in column (b) the gross receipts from the sales, rentals, or services on which the commissions arose, and in column (c), list the commissions earned. In column (d) report receipts from noncommissioned sales or rentals of property or furnishing of services, as well as all other receipts.

For purposes of completing line 1a and line 1b, related purchasers are members of the same controlled group (as defined in section 993(a)(3)) as the IC-DISC. All other purchasers are unrelated.

A qualified export sale or lease must meet a use test and a destination test in order to qualify.

The use test applies at the time of the sale or lease. If the property is used predominantly outside the United States, and the sale or lease is not for ultimate use in the United States, it is a qualified export sale or lease. Otherwise, if a reasonable person would believe that the property will be used in the United States, the sale or lease is not a qualified export sale or lease. For example, if property is sold to a foreign wholesaler and it is known in trade circles that the wholesaler, to a substantial extent, supplies the U.S. retail market, the sale would not be a qualified export sale, and the receipts would not be qualified export receipts.

Regardless of where title or risk of loss shifts from the seller or lessor, the property must be delivered under one of the following conditions to meet the destination test:

1. Within the United States to a carrier or freight forwarder for ultimate delivery outside the United States to a buyer or lessee.
2. Within the United States to a buyer or lessee who, within 1 year of the sale or lease, delivers it outside the United States or delivers it to another person for ultimate delivery outside the United States.
3. Within or outside the United States to an IC-DISC that is not a member of the same controlled group (as defined in section 993(a)(3)) as the IC-DISC that is making the sale or lease.
4. Outside the United States by means of the seller's delivery vehicle (ship, plane, etc.).
5. Outside the United States to a buyer or lessee at a storage or assembly site if the property was previously shipped from the United States by the IC-DISC.
6. Outside the United States to a purchaser or lessee if the property was previously shipped by the seller or lessor from the United States and if the property is located outside the United States pursuant to a prior lease by the seller or lessor, and either (a) the prior lease terminated at the expiration of its term (or by the action of the prior lessee acting alone), (b) the sale occurred or the term of the subsequent lease began after the time at which the term of the prior lease would have expired, or (c) the lessee under the subsequent lease is not a related person (a member of the same controlled group as defined in section 993(a)(3) or a relationship that would result in a disallowance of losses under section 267 or section 707(b)) immediately before or after the lease with respect to the lessor, and the prior lease was terminated by the action of the lessor (acting alone or together with the lessee).

Line-by-Line Instructions

Line 1. Qualified export receipts in line 1 are received from the sale of property, such as inventory, that is produced in the United States for direct use, consumption, or disposition outside the United States. These sales are qualified export sales.

Line 1a. Enter the IC-DISC's qualified export receipts from export property sold to foreign, unrelated buyers for delivery outside the United States. Do not include amounts entered on line 1b.

Line 1b. Enter the IC-DISC's qualified export receipts from export property sold for delivery outside the United States to a related foreign entity for resale to a foreign, unrelated buyer, or an unrelated buyer when a related foreign entity acts as commission agent.

Line 2a. Enter the gross amount received from leasing or subleasing export property to unrelated persons for use outside the United States.

Receipts from leasing export property may qualify in some years and not in others, depending on where the lessee uses the property. Enter only receipts that qualify during the tax year. (Use Schedule E to deduct expenses such as repairs, interest, taxes, and depreciation.)

Line 2b. A service connected to a sale or lease is related to it if the service is usually furnished with that type of sale or lease in the trade or business where it took place. A service is subsidiary if it is less important than the sale or lease.

Line 2c. Include receipts from engineering or architectural services on foreign construction projects abroad or proposed for location abroad. These services include feasibility studies, design and engineering, and general supervision of construction, but do not include services connected with mineral exploration.

Line 2d. Include receipts for export management services provided to unrelated IC-DISCs.

Line 2f. Include interest received on any loan that qualifies as a producer's loan.

Line 2g. Enter interest on any qualified export asset other than interest on producer's loans. For example, include interest on accounts receivable from sales in which the IC-DISC acted as a principal or agent and interest on certain obligations issued, guaranteed, or insured by the Export-Import Bank or the Foreign Credit Insurance Association.

Line 2h. On Schedule D (Form 1120), Capital Gains and Losses, report in detail every sale or exchange of a capital asset, even if there is no gain or loss.

In addition to Schedule D (Form 1120), attach a separate schedule computing gain from the sale of qualified export assets.

Line 2i. Enter the net gain or loss from line 18, Part II, Form 4797, Sales of Business Property.

In addition to Form 4797, attach a separate schedule computing gain from the sale of qualified export assets.

Line 2j. Enter any other qualified export receipts for the tax year not reported on lines 2a through 2i.

In some cases, an IC-DISC may have to enter a section 481(a) adjustment on line 2j. See Change in accounting method on page 5.

Line 3b. Enter receipts from selling products subsidized under a U.S. program if they have been designated as excluded receipts.

Line 3c. Enter receipts from selling or leasing property or services for use by any part of the U.S. Government if law or regulations require U.S. products or services to be used.

Line 3d. Enter receipts from any IC-DISC that belongs to the same controlled group (as defined in section 993(a)(3)).

Line 3f. Include in an attached schedule any nonqualifying gross receipts not reported on lines 3a through 3e. Do not offset an income item against a similar expense item.

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