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The Impact of the Proposed Tax Reform Bills on Manufacturing and Distribution Companies

The Impact of the Proposed Tax Reform Bills on Manufacturing & Distribution Companies

Within the last two weeks, the House Ways & Means Committee and the Senate Finance Committee released separate versions of their proposed tax reform bills.  While the markup of each bill is ongoing, further changes are expected to be released with the intent of having a bill ready for the President’s signature before the end of 2017. Both the House and Senate tax reform proposals seek to lower business and individual tax rates, modernize U.S. international tax rules and simplify the tax law, but they differ in some key aspects.

Continue reading for a comparison of the key tax provisions contained in the House and Senate proposals as the relate to manufacturing and distribution companies.

Corporate Tax Rate

  • Currently, the marginal rate system has a maximum rate of 35%
  • The House plan reduces corporate tax rate to a flat 20%. Personal service corporations have a flat 25% rate.
  • The Senate plan reduces corporate rate to a flat 20%. The same rate applies for all corporations, including personal service corporations. However, the rate is not reduced until 2019.

Flow-Through Tax Rate

  • Currently, flow-through income from sole proprietorships, partnerships and S corporations is taxed at the owner’s marginal tax rate.
  • House plan reduces maximum flow-through rate to 25%. However, for any investor who “materially participates,” the default setting is that only 30% of the income is attributable to the capital of the business subject to the 25% rate with the remaining income taxed at ordinary individual rates. Manufacturing and distribution companies may elect to apply a specified formula based on the business’s capital investments to determine an allocation greater than 30%. Passive owners of flow-through entities will enjoy the reduced 25% rate on all their flow-through income.
  • The Senate’s plan introduces a 17.4% deduction of the owner’s qualified business income. This deduction is limited to 50% of the wages paid to the owner by the business.

Depreciation

  • Currently, taxpayers can expense up to $500,000 of eligible property provided they don’t purchase more than $2,000,000 of property during the year.
  • House bill increase deductible amount to $5,000,000 with phase-outs beginning at $20,000,000 of purchases.
  • Senate bill increase deductible amount to $1,000,000 with phase-outs beginning at $2,500,000 of purchases.

Interest Deduction

  • With the exception of the earning stripping rules for large multi-national entities, interest expense is currently unlimited.
  • House plan will limit interest expense to 30% of adjusted taxable income with the disallowed amount carrying over for 5 years. This rule will not apply to businesses with less than $25 million of gross receipts.
  • Senate plan will limit interest expense to 30% of adjusted taxable income with the disallowed amount carrying over indefinitely. This rule will not apply to businesses with less than $15 million of gross receipts.

Uniform Capitalization Rules on Inventory (IRC §263A)

  • Currently, producers and resellers are subject to the uniform capitalization rules of §263A. Essentially, these rules bring additional, otherwise deductible, costs into ending inventory each year. There is an exclusion for resellers with less than $10 million of gross receipts.
  • House plan increases the gross receipts exclusion for both producers and resellers to $25 million.
  • Senate plan increases gross receipts exclusion for both producers and resellers to $15 million.

Cash Accounting Method

  • By default, C corporations with more than $5 million of gross receipts are currently required to use the accrual method of accounting. Additionally, any taxpayer for which the sale of inventory is an income producing factor must use the accrual method of accounting.
  • House plan increases the gross receipts limit to $25 million for both C corporations and inventory sellers.
  • Senate plan increases gross receipts limit to $15 million for both C corporations and inventory sellers.

International Taxation

  • Currently, income earned by foreign subsidiaries are only taxed when the money is brought back to the U.S.
  • House bill will move to a territorial system and provide a 100% dividends received deduction to U.S. corporations when amounts are repatriated from foreign subsidiaries. A one-time deemed repatriation would be imposed, under which the U.S. corporation would pay a 14% tax on any cash located in foreign countries.
  • Senate bill will move to a territorial system as well. A one-time deemed repatriation would be imposed, under which the U.S. corporation would pay a 10% tax on any cash located in foreign countries.

Research and Development Credit

  • Currently, taxpayers who incur qualified research expenditures can take a credit for the sum of in-house research expenses and contract research expenses paid or accrued.
  • Both proposed plans retain the R&D credit.

Domestic Production Activities Deduction (IRC §199)

  • Currently, domestic manufacturers get a 9% deduction on their qualified production activities.
  • Both the House and Senate plans eliminate this benefit.

Interest Charge Domestic International Sales Corporation (IC-DISC)

  • Currently, exporters are eligible for a rate arbitrage benefit and/or a deferral benefit. The manufacturer or distributor gets a commission deduction at ordinary rates and the owner of the IC-DISC receives dividend income at qualified rates.
  • Under the House plan, the rate arbitrage benefit is reduced however, the deferral benefits are still available. The rate arbitrage is eliminated for C corporations due to the reduced income tax rates but pass-through owners will still yield a rate arbitrage benefit.
  • Senate plan eliminates the IC-DISC regime but provides for a 12.5% tax rate for income from export activities.

What are the next steps for these proposals? The House of Representatives passed their tax proposal on November 16th but the Senate has yet to vote on their proposed plan. Assuming the Senate does pass the current plan, a reconciliation process must be conducted to merge the two plans together.

If you’d like more information or have questions relating to the tax reform bills on manufacturing and distribution companies, please fill out the form below.

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