Overview of Changes Affecting Manufacturers Under the Tax Cuts and Job Act
January 29, 2018 - By: SC&H Group
Below is a summary of the income tax changes that will impact manufacturers, along with some planning ideas to capture benefits and be aware of/minimize detriments. As always, you should speak with your tax advisor about specific issues and planning ideas before taking action. The following insights take a deeper dive into issues manufacturers should be taking the next steps to work through.
Corporate Tax Rates Reduced
One of the more significant new law provisions cuts the corporate tax rate to a flat 21%. This is something that will impact discussions about tax structure for existing and future entities.
Alternative Minimum Tax (AMT) Repealed for Corporations
This should factor into your 2018 estimated tax payment calculations. The corporate alternative minimum tax (AMT) has been repealed by the new law. Relatedly, corporations are allowed to offset their regular tax liability by AMT credit carryovers from prior years. Often, manufacturers may have incurred corporate AMT due to differences in deprecation and other deductions. For tax years beginning after 2017 and before 2022, the credit is refundable in an amount equal to 50% (100% for years beginning in 2021) of the excess of the AMT credit for the year over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the credit will be allowed in tax years beginning before 2022.
Net Operating Loss (“NOL”) Deduction Modified
Maximizing a 2017 tax loss would generally be advisable for carryback and 100% carryover availability. The new depreciation rules in affect for the last quarter of 2017 may assist in that capacity. Under the new law, generally, NOLs arising in tax years ending after 2017 can only be carried forward, not back. These NOLs can be carried forward indefinitely, rather than expiring after 20 years. Additionally, under the new law, for losses arising in tax years beginning after 2017, the NOL deduction is limited to 80% of taxable income, determined without regard to the deduction. Carryovers to other years are adjusted to take account of the 80% limitation.
Limit on Business Interest Deduction
This will be a significant issue for many manufacturing companies who have borrowed to finance equipment purchases, or who were planning on doing so in the future. This could also impact business owners who lease real estate to their manufacturing companies. Developing a game plan now to minimize any negative impacts is necessary, as the clock is ticking on most potential strategies.
Under the new law, every business, regardless of its form, is limited to a deduction for business interest equal to 30% of its adjusted taxable income. For pass-through entities such as partnerships and S corporations, the determination is made at the entity, i.e., partnership or S corporation, level. Adjusted taxable income is computed without regard to the repealed domestic production activities deduction and, for tax years beginning after 2017 and before 2022, without regard to deductions for depreciation, amortization, or depletion. Any business interest disallowed under this rule is carried into the following year, and, generally, may be carried forward indefinitely. The limitation does not apply to taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three-year period ending with the prior tax year. Certain additional rules apply to partnerships.
Domestic Production Activities Deduction (“DPAD”) Repealed
The new law repeals the DPAD for tax years beginning after 2017. The DPAD formerly allowed taxpayers to deduct 9% of the taxpayer’s (1) qualified production activities income (“QPAI”) or (2) taxable income for the year.
Qualified Business Income Deduction
Strategizing soon about how to maximize the deduction is important, as it can help reduce the maximum rate on pass through income from 37% to 30%. This new deduction will apply only to pass through entities and will allow 20% of the net income from manufacturing businesses to be subtracted from the taxable income of the partner or S corporation shareholder group that owns the business. The deduction is rather complex, but should help offset the loss of the DPAD noted above.
New Fringe Benefit Rules
Separate general ledger categories for what are now nondeductible expenses should be created now, to avoid revisiting history a year from now when preparing 2018 tax returns.
The new law eliminates the 50% deduction for business-related entertainment expenses. The pre-Act 50% limit on deductible business meals is expanded to cover meals provided via an in-house cafeteria or otherwise on the employer’s premises. Additionally, the deduction for transportation fringe benefits (e.g., parking and mass transit) is denied to employers, but the exclusion from income for such benefits for employees continues. Lastly, no deduction is allowed for transportation expenses that are the equivalent of commuting for employees except as provided for the employee’s safety.
Increased Code Sec. 179 Expensing
There are substantial changes to these rules. The new law increases the maximum amount that may be expensed under Code Sec. 179 to $1 million. If more than $2.5 million of property is placed in service during the year, the $1 million limitation is reduced by the excess over $2.5 million. The expense election has also been expanded to cover (1) certain depreciable tangible personal property used mostly to furnish lodging or in connection with furnishing lodging, and (2) the following improvements to nonresidential real property made after it was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; security systems; and any other building improvements that aren’t elevators or escalators, don’t enlarge the building, and aren’t attributable to internal structural framework.
Under the new law, a 100% first-year deduction is allowed for qualified new and used property acquired and placed in service after September 27, 2017 and before 2023. Pre-Act law provided for a 50% allowance, to be phased down for property placed in service after 2017. Under the new law, the 100% allowance is phased down starting after 2023.
Depreciation of Qualified Improvement Property
The new law provides that qualified improvement property is depreciable using a 15-year recovery period and the straight-line method. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property placed in service after the building was placed in service. It does not include expenses related to the enlargement of the building, any elevator or escalator, or the internal structural framework.
R&D Tax Credit
This credit survived and is still available to manufacturers. Changes to how these expenses are deducted will impact companies in their 2022 and forward tax years.
This credit survived the tax reform and should be revisited for manufacturers who export property.
Like-Kind Exchange Treatment Limited
Trading in equipment or vehicles will no longer be a nontaxable event. Under the new law, the rule allowing for the deferral of gain on like-kind exchanges of property held for productive use in a taxpayer’s trade or business or for investment purposes is limited to cover only like-kind exchanges of real property not held primarily for sale.
State Tax Issues
There are a number of issues facing state taxpayers from this Tax Act. Some that impact manufacturing businesses and their owners are noted below:
- Loss of the state income tax deduction for individuals – This will impact the pass through owners of manufacturing businesses in a significant way. It may result in revisiting your choice of tax structure, maximizing the QBI deduction noted above, utilization of C corporation subsidiaries where state taxes are deductible, etc.
- Maryland is looking at a statewide increase in the minimum wage, paid leave requirements
- Maryland is also looking to create and expand credits for manufacturing businesses, new businesses and credits for companies providing paid leave to their employees.
Before making any final decisions, we always recommend that you consult with your tax advisor to review options based on your situation. Please Contact Us if you have any questions as you navigate 2018 tax planning.