Balancing daily operations and long-term strategy is at the forefront of every chief financial officer’s mind, and in a business environment that is often riddled with a multitude of daily challenges and high demands on time, a focus on long-term success is required to maintain a company’s competitive edge. The temperamental climate surrounding local and global competition, supply chain management, regulatory modifications, environmental concerns and advances in modern technology are just a few of the matters manufacturing executives are asked to address daily. Commonly, the time and monetary investment to strategically address these types of challenges have little immediate impact but are more appropriately measured over the long term.
An equally important issue for every CFO surrounds the ever-changing income tax environment. While discussions surrounding corporate income tax reform and Congress’s guidance on corporate tax relief extenders seem nebulous and challenging when defining a tangible and reliable tax strategy, there are corporate tax planning and tax savings opportunities that can have both an immediate and meaningful impact on the finances of today’s manufacturing firms.
Here are five things every manufacturing CFO should consider when assessing the current tax environment.
Domestic Production Activities Deduction
A long-standing and extremely beneficial income tax deduction, commonly referred to as the “Section 199 Deduction” or “Production Deduction,” incentivizes income from manufacturing for production, growth and extraction activities derived in whole or in significant part from activities in the United States. The benefit allows for a deduction of 9% of qualified production activities income, as defined by the IRS. Although the deduction is limited to taxable income and 50% of W-2 wages, many companies will realize a benefit from the deduction.
Unlike many tax benefits that have recently been renewed at the end of the calendar year or made effective retroactively, the domestic production activities deduction has been made a permanent part of the code. Companies should incorporate the benefit of the deduction into their tax planning model for 2015.
State and Local Tax Considerations
State and local tax considerations can be extremely time-consuming for medium and large manufacturing companies. Constant changes to state and local tax codes and a general shift from “physical nexus” to “economic nexus” make compliance efforts very difficult.
Although states are competing with each other for your tax dollars, there are several items to consider that may reduce the tax burden: sales tax and personal property tax exemptions for manufacturing machinery, sales and use tax exclusions for items not sold to end-users, enterprise zone credits and renewable energy incentives provide companies with benefits related to state tax compliance. In addition, many federal tax credits (such as the Research and Development Tax Credit which is discussed below) are also recognized at the state and local level to further incentivize companies to operate within their jurisdiction.
Tangible Property Regulations
As a manufacturing company, capital expenditures and repair and maintenance expenses are inevitable to sustain or grow the business. The IRS has issued final tangible property regulations (effective January 1, 2014) that govern whether certain expenditures for or related to tangible property must be capitalized or expensed. The IRS issued the new regulations to formally conclude a ten-year process to reduce uncertainty on the common question of “capitalize or expense.”
In many cases, manufacturers will be able to realize current tax savings by implementing the new regulations. This requires additional analysis of the previous tax treatment for the acquisition of or on-going expenses related to tangible property and would be accomplished by completing additional forms and elections to be filed with the company’s 2014 corporate tax return.
Interest Charge -- Domestic International Sales Corporation (IC-DISC)
Providing goods and services to the international marketplace provides unique challenges along with some tax savings opportunities. The Interest Charge—Domestic International Sales Corporation, more commonly known as an IC-DISC, allows for exchanging a company’s ordinary corporate income tax rate for the dividend rate. The IC-DISC is a separate legal entity and must file an election with and receive approval from the IRS to take advantage of the preferential tax treatment.
There are a myriad of requirements, but the IC-DISC can be very advantageous for taxpayers that have qualified export receipts. The incentive is especially beneficial to closely held entities and may allow shareholders unique estate planning opportunities. To qualify, 95% of the IC-DISC’s gross receipts must be related to the export of property and exported assets must be 50% attributable to U.S.-based production.
Annual Tax Relief Extenders
Corporations have grown accustomed to the calendar year-end adjustments to taxable income based on Congress’s failure to timely address annual tax relief extenders. Although it becomes quite difficult to strategically plan to take advantage of tax policy, which was originally designed to encourage certain corporate behaviors, CFOs should pay attention to tax issues addressed by Washington during the year.
In particular, manufacturing companies should follow annual extenders related to “Section 179” and “Bonus” depreciation. If extended, the tax code would allow for additional tax deductions for qualifying property and equipment placed in service during the year. Additionally, tax breaks related to research and development costs have also historically been extended. CFOs may be surprised at the type of activities that qualify under the research and development tax credit.
Bryan C. Porter, CPA, is a principal in the Audit, Accounting and Consulting Department of Ellin & Tucker in Baltimore, MD, where he advises privately-held businesses in various industries, including manufacturing, wholesale distribution, construction, technology and not-for-profit. He is also a member of the firm’s Audit and Accounting Technical Standards Committee, which oversees programs designed to educate the firm and its clients on current accounting and business topics.