Many manufacturers are entering 2024 with high hopes. The universal supply chain disruptions spurred by COVID-19 are largely in the past, and persistent inflation and high interest rates are beginning to show signs of abating.
Yet challenges remain. Interest rates are still much higher than in recent years, which can be particularly painful for a capital-intensive industry like manufacturing. On top of that, changes built into the tax code—many of them written into the Tax Cuts and Jobs act of 2017 but deferred until now--impose a stricter limit on the ability of manufacturers to deduct interest expenses.
And that’s not the only deduction getting worse. Manufacturers are now required to capitalize and amortize research costs. In addition, bonus depreciation is scheduled to fall to 60% for property placed in service in 2024, meaning manufacturers can no longer fully expense investments in new equipment. (Lawmakers are considering legislation that would reverse these changes, so keep an eye on Congress.)
Fortunately, the tax code offers many benefits. The R&D credit remains a powerful incentive for manufacturers, and new energy credits can help companies both inside and outside the energy supply chain.
As 2024 begins, it’s an ideal time for manufacturers to assess their tax planning. Below are six key tax planning considerations for the new year:
Interest deductions: The deduction for net interest expense is generally limited to 30% of adjusted taxable income (ATI) under Section 163(j). Previously, ATI was similar to earnings before interest, taxes, depreciation and amortization. For tax years beginning in 2022 or later, depreciation and amortization must be included, lowering ATI. The change is particularly acute for manufacturers making large capital investments that create sizeable depreciation deductions. With high interest rates, more manufacturers than ever are being hit with this limit.
Manufacturers in danger of exceeding the cap may have opportunities to instead allocate interest to the development, production, construction or acquisition of a wide range of tangible and intangible property. Once recharacterized to another asset, the interest becomes part of the cost of that asset and is recovered using the accounting method applicable to that item. For example, if interest is recharacterized to a fixed asset, it would be recovered through depreciation deductions.
Bonus depreciation: Investments in manufacturing equipment can no longer be fully expensed. Property placed in service in 2023 was eligible only for 80% bonus depreciation, with the rest of the cost recoverable over the normal depreciable period. Property placed in service in 2024 will only benefit from a 60% bonus depreciation rate, with the rate further diminishing in future years.
Given the changes, it’s worth looking at opportunities to accelerate deductions for fixed assets. An analysis to identify costs that can be considered repairs has always been valuable when looking at structural property that doesn’t qualify for bonus depreciation. With bonus depreciation at 60%, this repairs analysis could also now significantly accelerate the cost recovery of other types of property. Manufacturers may also consider a broader cost-segregation analysis, which identifies costs eligible for recovery as property with a shorter depreciable period.
Research investments: For tax years beginning in 2022 and later, domestic research and experimental (R&E) costs under Section 174 must now be amortized over five years instead of being expensed. The IRS recently released important guidance on how to apply these rules. The guidance clarifies key areas, like the scope of software development, which must generally be capitalized under Section 174. Taxpayers should analyze the new rules, which are proposed to be applicable for tax years beginning after Sep. 8, 2023. Some of the rules provide favorable results, while others could present challenges and compliance burdens.
R&D tax credit: The R&D credit remains one of the most valuable incentives available to the manufacturing industry, which claims more credits than every other industry combined. The credit is even more valuable with the new requirement to amortize R&E costs under Section 174 because many companies discovered they had qualified activities for which they had never before taken the credit. Additionally, some taxpayers may no longer need to reduce either their R&D credit or the amount recovered under Section 174.
It’s important to remember that the R&D credit remains one of the most heavily audited and litigated tax issues. The IRS has won several recent cases based on the failure of taxpayers to establish that “substantially all” of the development activities constituted elements of the process of experimentation or that there was not sufficient uncertainty from the outset. Some taxpayers who lost recent cases could potentially have preserved partial credits under the ‘shrink-back rule’ if they had provided the documentation to apply their analysis to subcomponents of a project that did not qualify as a whole.
The Inflation Reduction Act’s energy tax package: These new credits can benefit many types of manufacturers.
Manufacturers with processes that create significant carbon emissions—including chemical companies, distillers, steel manufacturers, cement producers and paper companies—can apply under Section 48C for a 30% credit against the costs of investments to reduce emission by at least 20%.
Section 45X offers a powerful new credit for manufacturers that make wind, solar and battery components in the U.S. Even better, Section 48C offers a credit for a much broader range of manufacturing activities that goes well beyond renewables, including manufacturing products or components of energy and fuel storage systems, carbon-capture equipment, clean vehicle parts and charging infrastructure, grid modernization property, energy and thermal storage systems, critical minerals and other conservation technologies.
All manufacturers with energy needs should assess the potential benefits of using sources that qualify for the new broader and more lucrative investment tax credit under Section 48. It applies to traditional renewable energy sources like wind, solar and geothermal property, but has also been expanded to cover stand-alone energy storage, microgrid controllers and electrodynamic glass.
Global minimum tax: Multinational manufacturers with 750 million euros or more in financial statement revenue may also be affected by Pillar 2 rules starting as early as the 2024 tax year. While implementation is stalled here in the U.S., it is moving forward abroad. Pillar 2 is an Organization for Economic Co-operation and Development (OECD) initiative designed to ensure large multinationals pay a minimum tax rate on income in each jurisdiction where they operate.
Global adoption will affect U.S. multinationals in significant ways. Foreign income of their subsidiaries could be hit by those minimum taxes. Domestic subsidiaries of foreign parents with domestic income taxed at an effective rate below 15% could also be taxed more under the minimum tax in the parent jurisdiction.
The business environment isn’t getting any less complicated, so manufacturers should make sure they’re quickly addressing new challenges and planning opportunities. As companies head into 2024, it’s time to reassess business plans and consider the tax implications and planning options.