Most manufacturers can expect to fork over less in taxes for last year, and companies that monitor the shifting provisions could capitalize on greater investment in a few key areas.
Although most of the tax cuts from the federal Tax Cuts and Jobs Act of 2017 became effective for manufacturers on Jan. 1, 2018, businesses in all industries have been left with questions and uncertainty about how the new laws need to be applied, said Joel Mitchell, a tax partner at Plante Moran PLLC in Grand Rapids.
“There are certainly a large number of companies that will just pay less tax and the numbers will flush out by the time the tax returns are filed,” he said. “On the other hand, there are several businesses that may not be in the best position to take full advantage of the tax savings. Understanding the steps they need to take is still an open question for some taxpayers and a rather disappointing aspect of how these tax cuts have been rolled out.”
Still, most manufacturers should have seen some substantial benefits from the tax cuts already, according to Mitchell.
“It may be hard to fully quantify them still, but there are several areas where savings occur,” he said.
One of the most well-known federal cuts came to manufacturers that operate in a C corp structure, said Andy Zaleski, tax office managing partner in the Detroit office of BDO USA LLP.
“The corporate tax rate went from a maximum rate of 35 percent to 21 percent,” he said. “That was a significant benefit for manufacturers.”
For manufacturers that operate as pass-through entities, the top rate was reduced from 39.6 percent to 37 percent. They also can get another potential reduction because of the special pass-through deduction that gives taxpayers in a flow-through entity up to a 20-percent deduction against their taxable income, according to Zaleski.
“That, effectively, could reduce a manufacturer’s rate operating a pass-through or a flow-through entity structure from 39.6 percent under the old rules to 29.6 percent under the new rules,” he said.
To take advantage of this special 20-percent deduction, pass-through owners should analyze the new regulations for eligibility, Zaleski said. Proposed regulations that stipulate which types of businesses qualify were released in August.
“Generally speaking, most manufacturing companies should qualify for this,” Zaleski said. “There’s just significant and stringent compliance and documentation requirements associated with that deduction.”
Overall, manufacturers should take a close look to make sure they’re operating under the correct entity structure, whether the company is a C corp, S corp or a partnership, Zaleski said.
State, Foreign Changes
There are various aspects of the tax cuts that apply differently state by state, and manufacturers should keep an eye on which states adopt or opt out of new IRS provisions, according to Zaleski.
Although not directly associated with the tax cuts, last summer’s historic South Dakota vs. Wayfair Inc. Supreme Court case has brought vast reform to tax collection obligations online, for both sales tax and use tax, as well as income tax for multi-state manufacturers.
“This may not be as impactful for a manufacturer as it is for other industries, but is an area of significant change that every company should be aware of,” Mitchell said.
Manufacturers that operate overseas also may benefit from the Foreign Derived Intangible Income provision, according to Zaleski.
“It’s really a new deduction that U.S. companies are eligible for that have foreign operations,” he said. “That can be a significant benefit for that type of income.”
However, two other international provisions impose new burdens to manufacturers that operate in the U.S. and outside of the U.S. They are the Base Erosion and Anti-abuse Tax (BEAT), which amounts to a new minimum tax on base erosion payments for certain multinational groups that make payments to related foreign persons, and the Global Intangible Low-Taxed Income (GILTI) provision, which involves additional compliance for certain types of shareholders in foreign corporations.
Although the net effect from the recent tax reform “has been a mixed bag,” Dan Lynn, tax partner at Beene Garter LLP in Grand Rapids, has seen a lot of clients opt to reinvest their tax savings back into their businesses.
“People seem to be continuing with their investments,” Lynn said. “What we’re seeing is the labor market appears to still be pretty tight. People are having a hard time hiring people, and I think because of that dynamic of difficulty in hiring people, a lot of companies are making investments in technology.
“If they have a function in a machine that required two people to operate and they have an opportunity to purchase a different piece of machinery or do an upgrade so one person can operate it, people are making those decisions.”
Benefits of capital investments like equipment purchases have been enhanced through bonus depreciation deductions. Under previous tax law, a manufacturer was eligible to deduct up to 50 percent of equipment purchases in the first year, and typically, only new equipment qualified. The new rules expanded the eligibility to used equipment and allow businesses to claim the entire deduction at once.
“The new bonus depreciation rules definitely took away any sort of tax incentive to buy new equipment over used because used equipment wasn’t eligible for bonus depreciation before,” said Aaron VanSoest, a tax partner at the Grand Rapids office of Crowe LLP.
However, Zaleski said he hasn’t seen a change in the way his manufacturing clients have acquired new equipment. Where the credit provides a significant benefit is with mergers and acquisitions, he said.
“A manufacturer that acquires a company through an asset acquisition is generally eligible to apply these rules now to all of those assets that were purchased, and effectively write off up to 100 percent of those assets that were acquired in an applicable asset acquisition, as opposed to under the old rules, when they would have to depreciate it over its useful life,” Zaleski said.
In addition, the research and development credit is another place where manufacturers may come out ahead. Although there were not many changes to the credit itself, the tax rate change has made the credit “now worth incrementally more to taxpayers in manufacturing,” Zaleski said.
Overall, Zaleski predicts manufacturers may be even more comfortable investing their tax savings back into their businesses in 2019.
“I believe it could have the same effect that it had in 2018 and continue to spur investment in machinery and equipment for manufacturers, especially manufacturers that have been holding out on upgrading equipment, or expanding their businesses, or expanding their operating lines,” he said.
MiBiz Senior Writer Mark Sanchez contributed to this report.
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