The new federal tax law brings many changes for manufacturers. The impact is extensive, with benefits and drawbacks for companies that make products.
With a reduced corporate tax rate under the new law, some manufacturers will invest in more equipment and hire additional staff since more money will be available, while others, such as those that file as C-corporations, could miss bigger savings under a new business provision that exempts them from getting a considerable tax deduction.
Manufacturers got a chance to hear about how The Tax Cuts and Jobs Act will affect them at a program led by Concannon Miller & Co., a Certified Public Accountant and accounting firm of Hanover Township, Northampton County. A team from the firm shared its interpretation of the corporate and business elements of the new law with executives in the manufacturing industry at a program hosted by Manufacturers Resource Center in Hanover Township on Jan. 26.
The act, which became law in December, trims the corporate tax rate from 35 to 21 percent. The legislation also significantly reduces the income tax rate for corporations and eliminates the corporate alternative minimum tax.
It also provides a large new tax deduction for owners of pass-through entities and makes major changes related to the taxation of foreign income.
“It’s pretty far-reaching,” said Tony Deutsch, shareholder with Concannon Miller. “It’s probably the biggest tax act passed since 1986. Some are going to benefit tremendously. This bill is not tax simplification by any means.”
REPEALED TAXES, REDUCTIONS
The new bill repeals the corporate alternative minimum tax as well as the domestic production activities deduction, said Jane Spradlin, shareholder with Concannon Miller. This applies to all C-corporations, she added.
“This will affect everybody who makes something,” she said.
Companies will be taxed a flat rate of 21 percent for tax years beginning in 2018, Spradlin said. Also, there is no special rate for personal service corporations.
The new law also reduces the corporate dividends-received deduction. This deduction allows a company that received a dividend from a subsidiary to reduce that dividend by a certain percentage, thereby reducing the receiving company’s taxable income. These dividend-received percentages have been lowered from 80 and 70 percent to 65 and 50 percent, depending on the ownership of the subsidiary.
“There are accounting method changes that are available to all businesses,” Spradlin said.
REVENUE CEILINGS RAISED
Generally, simpler methods were previously allowed to those companies that had gross revenue of $10 million or less, she said. The new law raises those revenue (sales) ceilings to $25 million.
“This will allow manufacturers and other businesses to adopt methods of accounting that may be easier to implement and maintain,” Spradlin said. “Adopting these methods may reduce taxable income since companies will only recognize income and expenses when they receive or make cash payments.”
Also, the domestic production activities deduction is now gone. The deduction was significant for manufacturers and generally equal to 9 percent of the lesser of qualified production activities income or taxable income.
BONUS DEPRECIATION DOUBLES
Gregory Nease, a staff associate with Concannon Miller, shared details on how the new law affects bonus depreciation. A bonus depreciation allows a business to take an immediate first-year deduction on the cost of buying eligible business property, and increases it from 50 percent to 100 percent through 2022.
“The original use requirement is gone,” he said. “I think that’s a really big benefit.”
The changes in the act allow businesses to fully deduct the cost of an asset in the first year of use, instead of spreading this deduction over the useful life of the asset, Nease said. The effect on the tax return is that manufacturers have the opportunity for more deductions now, which will allow a business to lower its net income in the year it places the asset into service, he said.
Companies now have the ability to depreciate 100 percent of an asset, he said. Certain used property acquired by another company in a transaction now qualifies for 100 percent bonus depreciation.
Beginning with 2023, the bonus depreciation gradually reduces by 20 percent per year.
INCREASE TO $1M
The law also allows manufacturers to increase the amount they can expense under Section 179 to $1 million. It also increases the phase-out threshold – or the gradual reduction of a tax credit as the taxpayer approaches the income level to qualify for that credit – to $2.5 million.
The law indexes these amounts for inflation for tax years beginning after 2018.
The advantage of this is that a business can fully deduct the cost of an asset in the year that it’s placed into service, he said.
Andrew Desiderio, manager at Concannon Miller, discussed changes to the limitations on what manufacturers can deduct, including business interest expenses, noting that the law places a cap on adjusted taxable income, limiting it to 30 percent, effective in 2018 and beyond.
“That’s a huge change, obviously,” Desiderio said.
Research and experimentation expenses also see a big change, effective in 2022. Presently, companies can expense these as they incurred – in that tax year – or choose to amortize over 60 or more months. The option to expense the entire cost the first year will be eliminated.
This means that if a company incurred $100,000 of R&E expenses, under the existing law, it could be deducted fully in that year. Under the new law beginning in 2022, $20,000 would be deducted each year for five years, delaying the tax benefit.
Also, software development is now included under this R&E change.
“That’s obviously unfavorable for everyone in this room,” Desiderio told the audience, referencing the R&E changes.
QUALIFIED BUSINESS-INCOME DEDUCTION
One of the key benefits in the law is the qualified business income deduction, which is available to all taxpayers except C-corporations.
It’s something that clearly benefits “pass-through” entities, which are those small businesses such as S-corporations, sole proprietorships, partnerships and limited liability companies whose profits are passed directly through the business to the owners and are taxed on the owners’ tax returns through the individual income tax code.
“You may want to consider becoming an S-corp if you are a C-corp,” Deutsch said.
The Section 199A 20-percent qualified business income deduction is a very significant tax savings for successful entrepreneurs and investors of a pass-through business, Deutsch said. The deduction allows a person to “not pay income taxes” on the lesser of 20 percent of his or her taxable income or 20 percent of his or her qualified business income.
This applies for tax years from 2018 through 2026. However there are restrictions and requirements that kick in when a taxpayer’s income rises above a threshold amount.
“That deduction can get pretty big,” Deutsch said.
As a simple example, the owner of a pass-through business, including a manufacturer, that earns $100,000 of qualified business income will potentially get a $20,000 tax deduction, calculated as 20 percent of $100,000.
“It’s never going to be more than 20 percent of your taxable income,” Deutsch said.