Preface: A tax accountants has multiple roles for clients, 1. Provide tax compliant filings for the business, and 2, minimize the tax liability for the shareholders or partners. 3. Educate on what a tax compliant filing is, and how minimize the tax liabilities. This blog is untongue tied tax pertinent information for manufacturing businesses thinking about ways to reduce tax liabilities and maintain compliant tax filings.
Tax Attributes Specifically Relevant To Manufacturing Businesses
An important tax benefit for manufacturers is the domestic production activities deduction (DPAD), also known as the manufacturing deduction. The deduction is equal to nine percent of the lesser of the taxable income or qualified production activities income (QPAI). The deduction is available if a business has income from the rental, sale or other disposition of tangible personal property, buildings (but not land), computer software, and other products. The products must have been manufactured, produced, grown or extracted primarily in the United States. The deduction is also available for income from certain services, such as engineering and architecture. The deduction is reported on Form 8903, Domestic Production Activities Deduction. The DPAD tax benefit is deduction from business income, for tax but not book. It reduces income on the taxed income only, yet requires no cash payments. The sole purpose of this tax benefit is encourage manufacturing enterprises and economic vibrancy. DPAD has numerous applications for beyond typical manufacturing revenue, and production activity revenue is key to the deduction amount.
Depreciation – the write-off of the cost of an asset – is an essential element of tax accounting for a business. Property is depreciable if it is used for business, has a useful life exceeding one year, and may wear out or lose value from natural causes. Property that appreciates in value can still be depreciated if they are subject to wear and tear. Depending on how much income is generated by the business, the general goal in taking depreciation is to be able to write off property over the shortest period available, based on the property’s useful life. Most property is depreciated under MACRS, the Modified Accelerated Cost Recovery System. However, rather than claiming depreciation deductions, intangible property is amortized under Code Sec. 197. Taxpayers can also use cost segregation studies to reduce the period over which specified assets must be depreciated.
Special tax provisions provide accelerated write-offs of assets. These include bonus depreciation and the Code Sec. 179 expensing election. Depending on the current state of the law, companies claiming first year bonus depreciation may be able to write off 50 percent or more of an asset’s cost, in addition to the deduction allowed under MACRS depreciation. The expensing election allows a company to write off the entire cost of an asset up to the limit in the tax code. For 2016, the limit is a total of $500,000, e.g. manufacturing businesses looking to automate floor production, the investment in substantial equipment can likely be realized in immediate tax savings.
To accelerate deductions and avoid having to depreciate asset costs over a period of years, companies may treat certain costs of maintaining its assets as repairs or maintenance, generally deductible in full in the year paid. In late 2013, the IRS issued so-called “repair regulations” that explain when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible property. The regulations have many provisions that enable taxpayers to deduct their costs more easily and that reduce the need to maintain depreciation schedules. These provisions include the de minimis expensing rules of say up to $2,500 purchases, the write-off of expenses for materials and supplies, the deduction of recurring maintenance costs, and the replacement of building systems.
Taxpayers that produce merchandise and goods for sale are required to account for raw materials, supplies, work-in-progress and finished goods that comprise the items being manufactured. Taxpayers required to use inventories generally must use the accrual method of accounting. Accounting for inventories must reflect the best accounting practices of the taxpayer’s trade or business and must clearly reflect income. Permissible inventory accounting methods include FIFO (the first-in, first-out method); LIFE (last-in, first out) and average cost. Some taxpayers may also use the lower of cost or market (LCM) method.
Companies may claim the research tax credit for increased research expenditures in business-related activities. The credit generally is equal to 20 percent of the increase in qualified research expenses over a base amount, although there is an alternative simplified credit (ASC). The credit is not available for research activities conducted after the beginning of commercial production of a business component. Yet, if your company is developing a more powerful mic for gathering sound with waterfall noise level environments, the research credit would be applicable.
Summary: while the tax code optimizations highlighted are pertinent to minimizing taxes for manufacturing business, the content of this blog is only to provide an awareness of tax management strategies in say the manufacturing industry. Before making any tax decisions, talk with your trusted tax accountant.