The 2017 tax act demonstrates a continued effort to create jobs in the manufacturing industry. The act eases tax burdens on manufacturers, both corporate and non-corporate, and increases the threshold at which small manufacturers can use preferable accounting methods. While manufacturers do lose a much cherished deduction, increased expensing and reduced tax rates should more than make up for the loss.
Deductions and Credits
Taxpayers may immediately expense the full cost of qualified property acquired and placed in service before 2023 (“bonus depreciation”). The act removes the requirement that taxpayers are the original user of the property so long as the property is not acquired from a related person or entity. This additional expensing is set to phase down 20% every year after 2023, and ultimately is set to expire after 2027. The act also expands “§179 expensing” allowing taxpayers to immediately expense up to $1 million of the cost of certain depreciable assets acquired and placed in service in the tax year. The amount available for immediate expensing is reduced by the amount which the cost of the assets exceeds $2.5 million. Unlike the changes to bonus depreciation, the changes to §179 expensing are indexed to inflation and not set to expire.
Not all news is good news, and the same goes for tax news. The act repeals §199 – the deduction for domestic production activities. While the act retains the research and development tax credit, it requires the capitalization and amortization of research and experimental expenses over 5 years (15 years if the expenses are attributable to research outside of the United States). On a positive note, the capitalization and amortization requirement does not go into effect until 2022.
Corporate and International Concerns
Manufacturers organized as corporations will see a much lower effective tax rate in 2018, with the corporate tax rate reduced to a flat 21% and the corporate AMT repealed. Manufacturers that were subject to the corporate AMT in prior years will be able to use the prior year minimum tax credit to offset their liability, with a portion of the credit refundable from 2018 through 2021.
For multinational manufacturers, the act imposes a mandatory “repatriation” tax on accumulated foreign earnings. Taxpayers will be subject to a tax of 15.5% on cash (or cash equivalents) and 8% on illiquid assets and may elect to pay the tax over 8 years.
The “Pass-Through Deduction”
Owners of pass-through entities engaged in manufacturing are likely to see a significant benefit from the new deduction for qualified business income (QBI). QBI is generally the net of ordinary business income and deductions effectively connected with the conduct of a trade or business in the United States, with some limitations. Like the familiar §199, new §199A is limited by taxable income, this time 20% of the individual’s taxable income. Taxpayers are eligible for a deduction of the lesser of their combined qualified business income or 20% of their taxable income. Combined qualified business income is the lesser of 20% of the allocable share of QBI or the W-2 wage limitation. The W-2 wage limitation is the greater of (a) 50% of the allocable share of W-2 wages paid or (b) 25% of the allocable share of W-2 wages paid plus 2.5% of the allocable share of unadjusted basis of all qualified property. This second category permits manufacturers with lower payrolls to take advantage of the deduction. The W-2 wage limitation does not apply to individual owners with taxable income of less than $157,500 ($315,000 if filing jointly).
The deduction is set to terminate for tax years beginning after December 31, 2025.
Accounting Method Reforms for Small Manufacturers
Manufacturers have generally been required to keep inventories and the accrual method of accounting. Only small manufacturers with 3-year average gross receipts of less than $1 million were exempt. While the IRS provided relief several years ago for taxpayers with 3-year average gross receipts of less than $10 million, it explicitly omitted manufacturers from such relief. The act increases the 3-year average gross receipts test to $25 million (indexed for inflation) permitting any taxpayer who meets the test to use the cash method of accounting, account for inventories as materials and supplies that are not incidental, and exempt such taxpayers from the uniform capitalization rules.
Though the effects of tax changes vary business by business and taxpayer by taxpayer, the industry overall should see a reduced tax bill. Whether individual manufacturers use that reduction to create jobs remains to be seen.
Ashley Fausset is Tax Law Editor for Bloomberg Tax. She joined Bloomberg BNA in August 2017 after completing her LL.M. in Taxation at Georgetown University Law Center. She can be reached at [email protected].