The Tax Cuts and Jobs Act has provided us with a new tax landscape that includes a host of opportunities but also a number of traps for the unwary. The following is a summary of how tax reform impacts manufacturers and distributors, along with our insights on tax planning. Our Withum tax advisors have analyzed the new tax law and are ready to help you implement the various tax saving opportunities contained in the Act.
The corporate tax rate will drop from 35% to a flat 21% effective January 1, 2018. Fiscal year filers will transition by using a blended rate for their tax years beginning in 2017 and ending in 2018. The alternative minimum tax on corporations has been repealed for tax years beginning after December 31, 2017.
Planning Tip: Some companies, particularly ones in a growth mode, may benefit by converting to a C corporation to take advantage of the low 21% tax rate.
Starting in 2018, owners of “pass-through” entities such as partnerships, S corporations and sole proprietorships will be eligible for a Qualified Business Income (“QBI”) deduction. The deduction is equal to 20% of the QBI from the business and is claimed on Form 1040. The benefits provided by this deduction will result in a maximum federal effective tax rate of 29.6% for eligible taxpayers.
Planning Tip: Business owners need to evaluate their compensation levels relative to their pass-through income. Proper planning can result in as much as a 10.3% reduction in your federal effective tax rate.
This is relevant for manufacturers and distributors structured as pass-throughs. Top marginal tax rates for individuals are dropping from 39.6% to 37% starting in 2018. This rate benefit is offset for many taxpayers by the new limitation placed on state income taxes and property taxes. The so-called SALT (State and Local Tax) deduction will be limited to $10,000 for tax years beginning in 2018. Married taxpayers get an increased standard deduction in 2018 of $24,000 to help simplify their tax returns and offset the lost SALT deduction.
Planning Tip: With the loss of the SALT deduction, consider various alternatives, if feasible, in residency planning to reduce your state income tax burden.
Qualified property with a recovery period of 20 years or less placed in service after September 27, 2017 and before January 1, 2023 can be fully expensed. Property placed in service after December 31, 2022 and before January 1, 2028 will be eligible for additional initial expensing, but at an amount less than 100%. Additionally, prior law only allowed bonus depreciation for acquisitions of new property. The new law includes both new and used property in the definition of qualified property.
In addition to the “special depreciation” allowance provided above, taxpayers are allowed to deduct up to $1,000,000 of Section 179 expense. The deductible amount is reduced when more than $2,500,000 of qualified property is placed in service during a tax year.
Planning Tip: Conventional tax planning suggests to accelerate deductions as much as possible in order to defer paying tax liabilities. However, under the new tax law, the interplay between depreciation, the 20% pass-through deduction and the interest expense limitation must be considered in order to optimize the tax savings.
The deduction for interest will be limited to 30% of adjusted taxable income. Businesses with less than $25 million of average gross receipts will be exempt from this limitation. Any disallowed interest is carried over indefinitely.
Planning Tip: A special election can be made related to real estate financing to avoid the limitation on interest expense.
For tax years beginning in 2018, taxpayers with less than $25 million of average gross receipts will be exempt from the UNICAP rules.
Planning Tip: For eligible taxpayers this is a no brainer! The reversal of the cumulative UNICAP adjustment can be fully deducted in 2018.
Taxpayers with less than $25 million of average gross receipts can use the cash method of accounting beginning in 2018 regardless of entity structure. This is even applicable to taxpayers where the sale of inventory is an income-producing factor.
Planning Tip: The cash method of accounting provides much needed simplicity in tax law and can be a better match of cash flows to tax liabilities.
Taxpayers with ownership in a controlled foreign corporation with post-1986 accumulated foreign earnings will be subject to a one-time repatriation tax. The rate will be 15.5% on cash and cash equivalents and 8% on illiquid assets. Taxpayers will be able to elect to pay any resulting liability over and 8-year period.
Planning Tip: This is a one-time opportunity to repatriate cash at a low tax rate and a timely election must be made in 2018 in order to defer the tax liability over the 8-year period. Additionally, a planning technique through the use of an S Corporation can significantly defer payment of the tax liability resulting from the deemed repatriation.
The research and development tax credit has been retained under the new law.
Under current law, research and development expenses can be deducted in full when incurred, but under the new law must be capitalized and amortized over 5 years (effective tax years beginning after 12/31/21).
Planning Tip: This incentive typically results in a federal tax credit equal to 6.5% of qualifying expenditures. Most manufacturers are eligible to claim this credit… if you are not, you should!
Under prior tax law, the domestic production activities deduction generally provided a deduction equal to 9% of qualified production income. This tax incentive will be repealed for tax years beginning after December 31, 2017.
Planning Tip: In lieu of the DPAD; the new tax law provides a more robust 20% pass-through deduction and a lower corporate tax rate.
The IC-DISC tax regime still remains a part of the new tax law. Therefore, U.S. manufacturers and distributors who export products overseas may still benefit from this federal tax incentive.
Planning Tip: The two most common tax benefits derived from using the IC-DISC structure come in the form of a tax deferral and/or a reduction of your effective federal income tax rate. Under the new law; a qualifying exporter may benefit from a reduction in income tax rates of up to 5.8%.
Please contact either of us with questions on how tax reform impacts manufacturers and distributors or to discuss how the above tax savings opportunities apply to you.
David Poillucci, CPA, MST, Partner | firstname.lastname@example.org
Ian Taylor, CPA, MST, Manager | email@example.com