Year-End Tax Planning for Manufacturers


As the calendar year is coming to an end, manufacturers should be thinking about ways to implement tax savings strategies.  The Tax Cuts and Jobs Act of 2017 (“TCJA”), signed into law on December 22, 2017, brings numerous changes to corporate and individual taxation, and includes many exciting new tax laws aimed at reducing your tax burden.  The following are some of the highlights and opportunities available for implementation into your year-end tax planning strategies for manufacturers for the 2018 tax year.

Section 199A – Qualified Business Income Deduction

One of the most substantial tax savings opportunities under the TCJA is the new Section 199A deduction for qualified business income (“QBI”).  The deduction is available for manufacturers operating as S corporations, partnerships, LLC’s and sole proprietorships that result in the taxation of the shareholders/partners/members.  The Section 199A deduction allows for a deduction against taxable income equal to 20 percent of the combined QBI amount for the taxable year.

The new Section 199A deduction replaces the old Section 199 domestic production activities deduction (“DPAD”), which was a deduction equal to 9 percent of eligible domestic production income.  Under the TCJA, the former 9 percent DPAD deduction is replaced with a 20 percent deduction, which will result in substantial tax savings to manufacturing companies.  The 20 percent QBI deduction does have limitations calculated based upon wages paid and the cost basis of the company’s property, plant and equipment.  However, most manufacturing companies will not be affected by the limitation due to paying significant wages to employees.

Tax Rate Reduction for C Corporations

The TCJA has dramatically altered the tax structure for C corporations.  For tax years beginning after December 31, 2017, the TCJA permanently changed the corporate tax rate to a flat 21 percent rate for all C corporations.  Under the Pre-TCJA law, C corporations were taxed at graduated rates of 15 percent to 35 percent based on the company’s taxable income.

Certain C corporation manufacturing businesses operating in New York will also benefit from the special New York income tax rate of zero percent (0%), along with reduced capital base tax, minimum taxable income base tax and fixed dollar minimum tax rates.  The special New York income tax rate (0%) is for qualified New York manufacturers who satisfy property and receipt tests and meet certain employment requirements.  Paired with the new 21 percent Federal tax rate, qualified New York manufacturers will generate significant tax savings in 2018.

With the reduced Federal and New York tax rates for manufacturing businesses, there may be a planning opportunity to convert an existing S corporation, partnership or sole proprietorship manufacturing business to a C corporation.  The benefits and tax implications of a conversion will greatly depend on the individual circumstances of the business and must be closely examined on a case by case basis.

Section 179 Expensing and Bonus Depreciation

The TCJA has expanded on the existing Section 179 expensing and bonus depreciation to provide even more significant deductions against taxable income for manufacturers.  Through the PATH Act, most taxpayers have the opportunity to expense up to $1,000,000* in eligible fixed assets placed into service on or after January 1, 2018, pursuant to Internal Revenue Code Section 179.  Another important update to the Section 179 rules is the expansion of eligible property, which now includes certain improvements to nonresidential real property, including roofs, heating and air-conditioning property, fire protection, alarm and security systems.

In addition, the existing 50 percent bonus depreciation on qualifying property** has been significantly expanded under the new tax law.  For eligible property placed in service after September 27, 2017, manufacturers can also claim bonus depreciation of 100 percent of the cost of eligible property through 2022, 80 percent in 2023, 60 percent in 2024, 40 percent in 2025 and 20 percent in 2026.  It is vital to meet with management to discuss capital expenditure needs and discuss the timing of those expenditures based on the results of the year-end tax planning analysis.

Cost Segregation of Buildings or Building Improvements

Any building purchase, construction or large renovation project provides an opportunity to accelerate income tax deductions and provide cash flow benefits through a cost segregation study.  These studies separate the costs of the building and land improvements into assets with shorter lives which can accelerate tax depreciation deductions, as well as separate specific expenses that can be classified as repairs, resulting in a current year deduction.  The IRS also allows a “catch up,” for any previously missed depreciation deductions from prior years.  With the availability of the Section 179 rules and 100 percent bonus depreciation under the new tax law (discussed above), the tax savings on the cost segregation can be considerable.

Availability of the Cash Method of Accounting

Under the pre-TCJA tax rules, certain industries were not able to use the cash method of accounting due to the nature of their business.  Specifically, manufacturers, retailers, wholesalers and other similar businesses that have inventories were extremely limited in their accounting method choices.  Due to the presence of inventories, the taxpayers were required to use complex accounting rules pursuant to Internal Revenue Code Sections 471 and 263A, which govern the capitalization of overhead costs and certain selling, general and administrative expenses.

The TCJA amended the Internal Revenue Code to provide much more latitude to the use of the overall cash method of accounting.  Under the new rules, taxpayers with average gross receipts (average of the prior three tax years) that do not exceed $25 million are now eligible to use the overall cash method of accounting, where they may have been limited previously.

In addition to the $25 million gross receipts exemption, the TCJA also amended Internal Revenue Code Sections 471 and 263A, which govern the treatment of inventory costs.  Under the TCJA rules, the amended Tax Law provides a small business exemption where these complex rules would no longer apply to taxpayers meeting the $25 million gross receipts test.  Due to the new exemptions, the TCJA will allow manufacturers, retailers, wholesalers, and other taxpayers who do not exceed the $25 million gross receipts test to use the overall cash method of accounting.

With the availability of the cash method of accounting for many manufacturers beginning in 2018, it is extremely important to analyze the potential impact of a change to the cash method of accounting.  There are many planning opportunities available for a change in accounting method to the cash method that could result in extensive tax savings.  It is crucial to examine these items prior to year-end in order for the manufacturer to take the appropriate steps to maximize the available tax savings under the new rules.

Credit for Increasing Research Activities (R&D)

The Credit for Increasing Research Activities, which was written permanently into the tax law under the PATH Act of 2015, was not modified by the TCJA.  We routinely encounter manufacturers performing R&D activities that do not realize the activities being performed will qualify for the R&D tax credit.  Generally, if a manufacturer designs or improves a product, or has improved its production process, the costs related to the project will qualify.  There are several different methods available to compute the R&D tax credit which may reduce a substantial amount of income taxes.

Previously, manufacturing companies that generated R&D credits that were passed through to their owners were often limited due to the alternative minimum tax (AMT) applied at the individual tax level.  Under the TCJA, through increased AMT exemption amounts and the limitation on certain itemized deductions (previously added back for AMT purposes), the AMT limitations on the R&D credits will be significantly reduced, allowing taxpayers to claim more R&D tax credits against Federal income tax.

Work Opportunity Tax Credit (WOTC)

Manufacturers should take advantage of the Work Opportunity Tax Credit (WOTC) that can lead to substantial tax savings.  The WOTC, which was extended through December 31, 2019, rewards employers, requiring very minimal time and effort of the employer, that hire individuals from various targeted groups, including veterans, families receiving certain government benefits and individuals who receive long-term family assistance.  The WOTC is generally 25 percent – 40 percent of a worker’s first year wages from $6,000 to $24,000 depending on the individual’s hours worked and their specific targeted group.  For long-term family aid recipients, the credit is equal to 40 percent of the first $10,000 in qualified first year wages and 50 percent of the first $10,000 of second year wages.  It is important to note that in order to claim the credit, an employer must file a “Pre-Screening Notice Form” for the eligible employee with the Department of Labor within 28 days of the date of hire.

* Section 179 expensing is $1,000,000 per tax year, with a dollar for dollar phase-out of the deduction beginning at $2.5 million of qualifying fixed asset purchases.

** Qualifying property for the bonus depreciation rules is generally tangible personal property with a recovery period of 20 years or less.  Under the new law, qualifying property includes both new and used property, where the previous law restricted qualifying property to only new property.