Manufacturers and Distributors: Don’t Wait Until Year-End to Think About Taxes

This blog post was previously published on November 9, 2018. It was updated on November 18, 2019.

Several changes to U.S. tax laws over the past couple of years were intended to benefit businesses, and in particular, those in the manufacturing and distribution industries. As year-end approaches, set aside time for tax planning with your tax advisor so that you can maximize these benefits and minimize your tax liability for 2019.

Claim your R&D tax credit

Are you doing research and development? You may qualify for the R&D tax credit, even if you’re not sure you do. Several years ago, the credit was expanded to cover process development and experimentation, in addition to new product development.

The Tax Cuts and Jobs Act, which went into effect for tax year 2018, also indirectly increased the R&D tax credit’s after-tax benefit when it reduced the corporate tax rate to 21%. Additionally, the tax law’s removal of the corporate alternative minimum tax (AMT) gave more companies the opportunity to take advantage of the R&D tax credit.

The Tax Cuts and Jobs Act also limited the deductibility of net operating losses generated after December 31, 2017. Businesses can offset up to 80% of their taxable income using net operating losses occurring after 2017. Manufacturing companies expecting substantial revenue growth may consider taking advantage of their R&D tax credit now and applying it against the balance of taxable income that cannot be offset by their net operating losses.

Startups with less than $5 million in revenue (and no revenue for the period of five years ending with the credit year) can, in the absence of a tax liability, instead apply the R&D tax credit to offset up to $250,000 in payroll taxes each year for up to five years. To do this, you need to keep at least a minimum of documentation of your activities and eligibility. A qualified professional with R&D tax experience can help you assess your eligibility, calculate the amount you could expect from this credit, as well as advise and assist you with proper documentation for claiming the credit.

Finally, keep in mind that, for taxable years beginning after Dec. 31, 2021, taxpayers will be required to capitalize and amortize research or experimental expenditures (which will include software development costs) over a period of 5 years. Those costs are currently immediately deductible as expenses.

If you’re involved in manufacturing-related activities or processes that you think might be covered, you should consult an R&D tax advisor to learn more about the tax savings opportunities that may be available for your company.

Prepare to capture expanded bonus depreciation

Starting in 2018, bonus depreciation, a method of accelerated depreciation that allows you to take an additional deduction the first year you own qualified property, became more expansive. For property acquired after September 27, 2017, and through the end of 2022, 100% of the basis can be depreciated in the first year, and the property only has to be “new to the taxpayer,” meaning used property can qualify.

Year-end planning should include assessing any property purchased during the year.  Speak with your tax advisor about whether it makes sense to accelerate purchases to this year.

Evaluate your capital strategy

Manufacturers and distributors whose capital strategy is largely reliant on borrowing may see negative effects (i.e., increased cost of borrowing) from tax changes related to interest expense deductibility.

For net interest expense that exceeds 30% of adjusted taxable income, deductibility is now limited. A phase-in through 2021 means adjusted tax income is computed without accounting for depreciation, amortization or depletion; however, beginning in 2022 those items will be included in the calculation.

Planning should include consideration of other capital strategies.

Maximize your deduction for qualified business income (QBI)

Owners of certain pass-through entities may be able to receive a 20% deduction on QBI, which may reduce their maximum effective tax rate for 2019. Pass-through entities, which include subchapter S corporations, partnerships and some limited liability companies. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes.  

The deduction may be limited to 50% of W-2 wages paid, or the sum of 25% of the wages plus 2.5% of certain depreciable basis. Speak with your tax advisor about whether you have paid enough wages to use this deduction – if you’re close, now may be the time to pay bonus wages to employees.

Also, be aware that filers who claim the QBI deduction must now show how they calculated QBI, by using Form 8995. Each business must stand separately and will require its own Form 8995.

The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2019 should include discussion of salaries, timing and distribution of income.

Don’t forget to update your Transfer Pricing Study

If your company makes transactions between entities it controls in different countries, you likely need a regularly updated Transfer Pricing Study that demonstrates that those transactions are priced “at arm’s length.”  This is the contemporaneous documentation you need to stay in compliance with U.S. regulations designed to combat tax avoidance or tax shifting. In addition, the federal Tax Cuts and Jobs Acts of 2017 included provisions that might impact transfer pricing policies.

Although a company generally only must provide the IRS with a Transfer Pricing Study during an audit, you should have and implement an up-to-date study. Check with your tax professional about whether your Transfer Pricing Study is current and when to plan for the next study.

Contact your Kaufman Rossin tax advisor before year-end to learn more about how to maximize your 2019 tax deductions and credits via tax planning as you prepare for 2020.