In December 2017, the signing of the new tax reform bill led to the biggest modernization of the U.S. tax code since 1986. When the legislation came into full effect in the first quarter of 2018, it became an exciting time in the manufacturing industry.
It’s important for manufacturers to assess their unique situations and set a strategic plan to take advantage of the newest tax law’s benefits from investment incentives or direct savings. That’s why we’ve put together all the key takeaways for what tax reform means for the manufacturing industry.
Tax Rate Reduction
Prior to the U.S Tax Cuts and Jobs Act, corporations were subjected to rates based on their taxable income. Under pre-act law, the tax rates were:
- 15% for taxable income between $0-$50,000
- 25% for taxable income between $50,000-$75,000
- 34% for taxable income between $75,001-$10 million
- 35% for personal service corporations on their entire taxable income
The new legislation has dramatically cut corporate tax from 35% to a flat rate of 21% for tax years beginning after December 31, 2017.
Main takeaway for manufacturers: The introduction of the flat rate allows manufacturers to have greater stability and develop a more agile organization.
Change in Equipment Expensing
The Code Section 179 equipment expensing deduction was established to encourage small- to medium-sized businesses to invest in equipment, off-the-shelf computer software and qualified real property for active use in the trade of the business. To qualify for the deduction, the expensed goods must be used for the conduct of the business at least 50 percent of the time.
For tax years beginning after December 31, 2017, organizations are now able to deduct up to $1 million in equipment expenses, which has doubled from the previous expense limitation of $500,000.
Further changes under the U.S Tax Cuts and Jobs Act has increased the phase-out deduction from $2 million to $2.5 million after 2017, meaning the entirety of a deduction will disappear when a limit of $3.5 million in purchases has been reached. Furthermore, after September 27, 2017, a 100 percent first-year deduction was implemented for the adjusted basis of new and used qualified property that’s acquired and placed in service.
Main takeaways for manufacturers: Organizations in the manufacturing industry can now deduct up to double the amount in equipment expenses, up to $1 million. This makes investing in company growth a more fruitful investment for manufacturers.
Change in Tax Treatment of Inventory
Before December 2017, C corporations, C corporation partnerships and tax-exempt trusts weren’t able to use the cash method. This often applied to manufacturing businesses that must keep inventory records that distinguish the cost of goods sold for the tax year.
Proceeding the tax code overhaul, the new changes state that taxpayers under the $25 million gross receipts threshold aren’t required to account for inventories under Code Sec. 471. This applies to the taxpayer, whether the purchase, production or sale of goods is income producing. Instead, they’re able to use accounting methods for inventories that:
- Treat inventories as non-incidental materials and supplies.
- Conform to the organization’s financial accounting treatment of inventories.
Important note: If the cash method is used and an organization treats the inventories as non-incidental materials and supplies, they’re exempt from the inventory UNICAP rules of Code Sec. 263A.
Main takeaways for manufacturers: The change in tax treatment for inventory provides manufacturing and distribution companies with administrative simplicity and significant tax benefits.
Interest Expense Limitation
The Tax Cuts and Jobs Act limits the deduction of business interest expense to 30 percent of adjusted taxable income (ATI) of certain “large” businesses. There is a trap for the unwary that may surprise some companies.
Business interest expense includes:
- Current-year business interest expense
- Disallowed business interest expense carryforwards from prior years (except partnerships)
- Partner’s excess business interest expense
- Floor plan financing interest expense
ATI is taxable income computed without regard to:
- Income or expense items that aren’t properly allocable to a trade or business
- Any business interest expense not from a pass-through entity
- Net operating loss deduction
- QBI deduction allowed under IRC 199A
- Depreciation (see special note below), depletion or amortization for tax years prior to January 1, 2022
- Loss or deduction items from a pass-through entity
- The lesser of the gain on the sale of depreciable property, or the total depreciation, amortization or depletion on that property after 2017 and before 2022
For a manufacturer, the greatest concerns are whether the 30 percent limitation applies, and its impact on the taxable income of the organization. Generally, the limitation will apply if the taxpayer has annual gross receipts of $25 million or more, on average, for the three preceding tax years.
The proposed regulations clarify that tax depreciation to be added back to determine ATI is only depreciation deducted in the current year. So, depreciation capitalized into current, year-ending inventory is not an add-back for ATI. This is a potential trap for manufacturers. This clarification will subject significantly more manufacturers to the limitation.
Main takeaway for manufacturers: More manufacturers will be subject to the interest expense limitations due to the proposed regulations limiting the amount of depreciation that can be added back in calculating ATI. Taxpayers should be cautious to only capitalize into inventory the minimum depreciation allowable under the tax code and UNICAP.
After December 31, 2017, The Tax Cuts and Jobs Act has eliminated the deduction for all business-related entertainment. Expenses such as taking clients to sporting events, theaters, movies, concerts and amusement parks will no longer be deductible.
Employers and taxpayers are still able to deduct entertainment expenses that are included in employee W-2 wages. Furthermore, expenses can be deducted for recreational and social activities that are primarily for the benefit of the organization’s employees.
Main takeaways for manufacturers: Wining and dining clients has become even more expensive, as the majority of conventional entertainment expenses are now non-tax deductible. For manufacturers, this may have a negative impact on seeking out and creating new deals with new partners, vendors and distributors.
Each business is unique, and each has different needs. For more information about how your manufacturing company should respond to the items and takeaways outlined above, connect with a Warren Averett advisor.