Manufacturers, Distributors: Don’t Overlook 2020 Tax Planning Opportunities
Many manufacturing and distribution firms have made significant changes to their supply chain, operations or even business model during the COVID-19 pandemic. Your business may have experienced significant revenue loss or change to the valuation of assets.
Along with these changes, the Coronavirus Aid, Relief and Economic Security (CARES) Act and other pandemic-relief measures at the federal and state level have changed tax rules, specifically with the intention of helping manufacturers and distributors. 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 2020.
You may be able to take larger deductions for net operating losses
Many manufacturing and distribution companies experienced losses this year related to the pandemic. The CARES Act gives temporary reprieve from Tax Cuts and Jobs Act (TCJA) provisions that stopped the carryback of net operating losses (NOLs) and limited their use to 80% of taxable income.
Notably, the CARES Act:
- Grants a five-year carryback period for NOLs arising in tax years beginning January 1, 2018, and ending December 31, 2020.
- Temporarily suspends the 80% of taxable income limitation on the use of NOLs, allowing taxpayers to fully offset taxable income during the allowed tax years, regardless of when the NOL was generated.
You may want to take advantage of the carryback by amending or modifying tax returns for tax years dating as far back as 2013. Due to the change in tax rates, it may be more beneficial to carry losses back to higher rate tax years.
Claim your R&D tax credit
The pandemic has led many manufacturing and other businesses to dramatically transform their operating models and change their product offerings. If your company’s activities have involved developing new or improving existing processes, software or products, your company might qualify for the research and development (R&D) tax credit. Even if you expect to report a loss this year, you may still want to capture the R&D tax credit for utilization against future taxes.
For manufacturers, situations triggered by COVID-19 that could lead to research and development expenditures eligible for the R&D tax credit include transforming your standard processes to manufacture and distribute personal protective equipment or to ramp up the production of high-demand household consumables. The development or improvement of manufacturing processes often requires experimentation and a series of costly trials to reach product specifications.
Issues with the supply chain have also led many manufacturers to experiment with alternative raw materials and redesign certain products. If any of this sounds like your business, check with your tax advisor to see if your company qualifies for this credit.
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.
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 five 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, consult an R&D tax advisor to learn more. A qualified professional with R&D tax experience can help you assess your eligibility, calculate the amount of tax savings you could expect from this credit, as well as advise and assist you with proper documentation for substantiating the credit.
Consider any pandemic-relief credits you may not have taken advantage of
Federal, state and local governments have provided some relief to manufacturers by allowing them to defer various tax payments, including income, sales and use and payroll taxes. Some of these deferrals and credits can make it more complicated to calculate upcoming estimated tax payments. Discuss with your advisor which payments you should make before year-end 2020 and which ones you can defer until 2021.
State and local taxes may be more complicated
Did you change suppliers, shift manufacturing operations to different states or different countries, or have some of your workforce telecommuting from states where you don’t normally have operations? If so, your tax reporting and payment obligations may have shifted, too.
Here are a couple of things to keep in mind:
- Even if they are only telecommuting temporarily because of COVID-19, workers working from home in other states may create nexus in that state or change the apportionment of taxable income in states where you already had nexus.
- Not all states adopted CARES Act provisions into their own codes.
Don’t forget to update your transfer pricing study
If your company transacts business between related entities in different countries, you will 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.
Transfer pricing studies generally need to be updated yearly. You may have more changes than usual this year if you experienced supply chain changes or disruptions, or if your international sales flow changed.
You might use a simpler method to allocate costs to ending inventory
In late 2019, the IRS and Treasury released final regulations related to tax inventory capitalization under Section 263A of the Internal Revenue Code (IRC); these regulations applied to any tax year beginning after November 19, 2018.
Among other things, the regulations added another method for allocating additional Section 263A costs to ending inventory: the modified simplified production method (MSPM). For larger manufacturers, the MSPM may offer a far simpler method for allocating these costs, and may result in lower Section 263A capitalization than the SPM. This can provide significant benefits to manufacturers. If you didn’t adopt the MSPM last year, you may want to consider whether you should adopt it this year.
Assess whether you should 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 must only be “new to the taxpayer,” meaning used property can qualify. In addition, qualified improvement property (QIP) is now also eligible for 100% bonus depreciation.
Furthermore, the CARES Act fixed a Congressional oversight and QIP is now back to being classified as having a 15-year depreciation (rather than a 39-year period). Most non-structural improvements you make to the interior of a non-residential building are considered QIP. These changes apply retroactively to property acquired and placed in service after December 31, 2017, and include tax year 2020. You may want to consider amending your 2018 and 2019 taxes (if you haven’t already) or filing Form 3115 Application for Change in Accounting Method to claim the extra depreciation.
Year-end planning for 2020 should include assessing any property purchased during the year and any QIP. And, if you’re considering purchases or improvements, speak with your tax advisor about whether it makes sense to accelerate them to this year or delay until next year.
Temporary changes to business interest expense rules
Manufacturers and distributors whose capital strategy is largely reliant on borrowing may find that the CARES Act provides temporary relief from the negative effects of the TCJA’s limits on business interest expense deductions.
- For corporations, the CARES Act temporarily increased the IRC Section 163(j) limitation on allowable deductions for business interest expense to 50% of adjusted taxable income, for both 2019 and 2020 (after a reduction to 30% beginning in 2018). This provision also allows the use of 2019’s adjusted taxable income to calculate the limitation for 2020. That 30% limit returns for 2021.
- Partnerships, however, only get to use the higher 50% limitation for tax year 2020. If you as a partner are carrying forward excess business interest expense from 2019 into 2020, you can automatically claim half of that excess in 2020 unless you elect out.
The 30% limit is scheduled to return for tax year 2021. In addition, adjusted taxable income is currently computed without accounting for depreciation, amortization or depletion; however, beginning in 2022 those items will be included in the calculation. This information may change your capital strategy for the end of this year or into 2021. Consult your tax advisor to discuss.
Maximize your deduction for qualified business income (QBI)
As in tax year 2019, owners of certain pass-through entities may be able to receive a 20% deduction on QBI, which could reduce their maximum effective tax rate for 2020. Pass-through entities 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.
Paycheck Protection Program loans
As it stands right now, Paycheck Protection loans that are forgiven will not count as taxable income, but businesses also cannot deduct any expenses paid with those funds. And while this isn’t strictly a tax-planning issue, it may be the most important year-end task you undertake if you received a PPP loan: Decide whether to apply for PPP loan forgiveness now or wait. You must begin making payments on your loan 10 months after the last day of your loan forgiveness covered period, but you can apply for forgiveness any time before the loan’s maturity date.
Contact your Kaufman Rossin tax advisor before year-end to learn more about how to maximize your manufacturing or distribution business’ 2020 tax deductions and credits via tax planning as you prepare for 2021.