This blog post was originally published on February 19, 2018. It was updated on November 9, 2018.
Top tax planning tips for year-end 2018
As we shared earlier this year, the Tax Cuts and Jobs Act included tax changes that are positive for the manufacturing and distribution industry as well as provisions that are negative. Now that year-end 2018 is closing in, it’s urgent that you take the time for proper planning with your tax advisor. Without the proper planning before year-end, you could miss out on benefits.
Most urgent: Maximize the new deduction for qualified business income (QBI).
The new tax law includes a QBI deduction break for owners of certain pass-through entities, which is the structure of many manufacturers. This deduction may reduce your maximum effective tax rate for 2018.
Owners of qualifying pass-through entities will now receive a 20% deduction on qualified business income, effectively reducing their maximum effective tax rate from 39.6% in 2017 to 29.6% in 2018. Pass-through entities include subchapter S corporations, partnerships and some limited liability companies.
The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2018 should include discussion of salaries, timing and distribution of income.
Get your R&D tax study started.
Are you doing research and development? You may qualify, 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. If you’re involved in activities that you think might be covered, you should consult a tax advisor with experience in claiming and documenting the R&D tax credit to learn more about the new tax savings opportunities that may be available.
The R&D credit has long been a tax benefit many businesses overlooked, you can’t afford to overlook it any longer. As a result of tax reform, the R&D credit is now more valuable than ever. Previously, an R&D tax credit of $500,000 would have yielded a net benefit of $325,000. Now this credit results in a net benefit of $395,000, a 21.5% increase. That’s because businesses are required to reduce the amount of research and development expenditures they deduct from their taxable income by the amount of their R&D tax credit. The lower corporate tax rate in the new law results in a larger net benefit from the R&D tax credit when applying the lower 21% rate to the disallowed deduction, when compared to the prior 35% rate. Plus, the new limits on deductibility of net operating losses and the repeal of the AMT mean companies will benefit more from the R&D tax credit.
Manufacturers expecting substantial revenue growth may want to apply their R&D tax credit against the balance of taxable income that can no longer be offset by net operating losses.
Prepare to capture expanded bonus depreciation.
The new tax law changes the rules for bonus depreciation, a method of accelerated depreciation that allows you to take an additional deduction the first year you own qualified property.
Previously, bonus depreciation was calculated at 50% of the basis of qualified property, and only brand new property qualified. For property acquired after September 27, 2017, and through the end of 2022, 100% of the basis can be depreciated, 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. You may also want accelerate purchases to this year, if it’s advisable.
Two less positive changes also require planning.
The Domestic Production Activities Deduction was repealed. Qualifying U.S. manufacturers with taxable income were previously allowed to claim a 9% deduction on goods produced in the United States. However, the new tax law repeals the Domestic Production Activities Deduction. The lower corporate rate and other provisions mentioned above are expected to offset the loss of this deduction, which was a favorite among the manufacturing industry.
Planning might include evaluating the cost and tax implications of transitioning production elsewhere, now that this deduction is eliminated.
Limits on interest expense deductibility will increase cost of borrowing. Manufacturers and distributors whose capital strategy is largely reliant on borrowing may see negative effects 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.
With so many changes to the tax code, planning early is more important than ever. Contact your Kaufman Rossin tax professional before year-end to learn more about how the Tax Cuts and Jobs Act could affect your business.