Tax Saving Opportunities for Manufacturers
Strategic Tax Planning for Manufacturers in the Face of Inflation & Regulatory Challenges
Planning season is right around the corner for most taxpayers. Although recent data shows inflation slowing, many manufacturers are continuing to face challenges such as increased borrowing costs, finding employees, additional regulations and supply chain issues. It is more important than ever to plan for income taxes and maintain control of cash flow. There are many potential opportunities to consider when working with your advisor.
Research & Development Credit
A Federal credit to help offset tax liability is available to certain manufacturers developing new or improved business components, including products, processes, computer software development, techniques, formulas or inventions that result in new or enhanced functionality, performance, reliability or quality.
The amount a manufacturing company can save with the R&D tax credit depends on several factors, including size, qualifying expenses and effective tax rate. Companies can generally claim a credit of up to 20% of their qualifying R&D expenses. Developing a customized project plan is crucial to identify, calculate and support your company’s R&D credits and activities. Learn more about How Manufacturing Companies Can Maximize Their R&D Tax Credit Savings.
Accounting Method Changes
Manufacturers can request a change in accounting method by submitting Form 3115 to the IRS. These changes can defer income associated with deposits, advance payments or long-term contracts and accelerate expenses related to prepaid items, software development, certain accruals or fixed asset depreciation methods. Companies with average gross receipts below $29 million for 2023 are categorized as “small businesses” and may have additional planning opportunities.
Cost Segregation Studies
Manufacturers may decide to implement a cost segregation study when expanding facilities, either by new construction or purchase. These studies help identify certain manufacturing facility costs that may qualify for depreciation lives shorter than 39 years and may be eligible for accelerated depreciation methods. If a cost segregation study was missed in the year of purchase or construction, the taxpayer might still have the option to file Form 3115 and request an accounting method change.
Qualified Business Income (QBI) Deduction
Manufacturers taxed as a pass-through entity (partnership or S Corporation) may be eligible for an additional tax deduction. QBI, also known as Section 199A, allows for a deduction up to 20% against qualifying net business income. The deduction is passed through and claimed on the individual partner or shareholder’s tax returns. Unless Congress provides an extension, the QBI deduction is currently scheduled to “sunset” after 2025.
Certain manufacturers may have an opportunity to elect to change their inventory method to last-in, first-out (LIFO). LIFO inventory allows taxpayers to leave older inventory costs on the balance sheet while writing off the latest costs first in the cost of goods sold (COGS) calculation. This method may be advantageous in a business environment experiencing significant cost increases.
Accelerated depreciation methods are still available to manufacturers, notably bonus depreciation and Section 179. For 2023, bonus depreciation allows taxpayers to immediately expense 80% of the cost of certain business assets with shorter depreciable lives in the year they are placed in service. The allowable first-year expense will be decreased to 60% in 2024 and will continue to be phased down by 20% each year through 2026. Unless Congress extends it, it will expire in 2027.
Section 179 also allows for an immediate write-down of certain assets in the year they are placed in service. Section 179 is limited to taxable income from trade or businesses. For 2023, a maximum deduction of $1.16 million is allowed before the total purchase phase-out begins at $2.89 million.
State & Local Tax
The state and local tax landscape is continuously changing with increased complexities and compliance. It is more important than ever for businesses to align themselves with a tax professional who can keep them informed and help navigate these numerous issues.
Armed with the 2018 U.S. Supreme Court decision, (South Dakota v. Wayfair), states have become more aggressive in collecting sales tax. Additionally, over the past three years, a flurry of legislation has been passed implementing an entity-level state income tax for pass-through entities. Other opportunities on the state and local level may include:
- Entity structuring
- Obtaining certain investment credits
- Accessing local economic development funding programs
- Sales tax exemptions and property tax abatements
When it comes to navigating the challenges of the manufacturing industry, having a strategic ally is crucial. With new tax laws and increased compliance on both the Federal and state levels, it’s important to have someone who can help your business stay on top of these issues. Contact an Adams Brown manufacturing advisor today.