Tax reform will affect all manufacturers, and the window of opportunity for many planning ideas is short. Assess the impact of tax reform on your business's tax positions immediately.
December 2017 brought a sweeping tax reform bill into sharp focus. The most significant tax legislation in several decades, the Tax Cuts and Jobs Act (TCJA) has implications for manufacturers of all types and sizes.
Tax reform reduces the taxes on most manufacturers, whether they’re taxed as a C corporation or as a pass-through entity. The legislation also modifies certain business deductions. Some, such as depreciation, will be significantly enhanced while others, like interest expense, will be limited. Several deductions and credits have been significantly altered or repealed altogether.
Although 2017 has come to a close, there are still several things manufacturers can do now to optimize their tax position for the 2017 tax year. Fiscal-year businesses whose year ends have not yet closed have even more planning opportunities available to them.
Taking advantage of existing accounting methods often requires certain actions to occur within a specified period of time after the year end.
Six steps manufacturers should take for the 2017 tax year
Since the effective rate for business income will decrease for most business taxpayers, many planning items for the 2017 tax year revolve around deferring income into 2018 and accelerating deductions into 2017. For a C corporation whose tax rate is dropping from 35 to 21 percent, every dollar of accelerated deduction or deferred income generates a permanent savings of 14 percent. Similarly, for a pass-through entity whose tax rate may be dropping from 39.6 to 29.6 percent (after considering the effect of the new qualified business income deduction), the same planning step results in a permanent savings of 10 percent.
Tax accounting methods
Changing accounting methods or adjusting practices to maximize the benefits of existing accounting methods are some of the most impactful planning strategies available. This could involve a number of things such as:
- Paying certain compensation sooner than it is normally paid
- Writing off certain inventory or accounts receivable
- Expensing certain capitalized research expenses
- Expensing certain prepaid expenses
That said, only automatic accounting method changes can be filed in 2018 and still apply to the 2017 tax year.
The bottom line:
Taking advantage of existing accounting methods often requires certain actions to occur within a specified period of time after the year end. Since manufacturers will want to take time to analyze the viability of new methods and whether each is eligible to be made on an automatic basis, it's imperative to quickly understand the ramifications of tax reform and act promptly if warranted.
Significant changes were made to depreciation rules, including the increase in bonus depreciation to 100 percent and the expansion of the types of assets eligible for the new rules. Two important planning tools for depreciation include:
Properly applying new depreciation rules
The 100 percent bonus depreciation rules will apply to assets — both new and used — that were acquired and placed in service after Sept. 27, 2017. Determining the dates property was placed in service is even more important now since property not eligible for the new rules will be subject to the previous bonus depreciation rules.
Depreciation accounting method changes
Another method of accelerating depreciation deductions is to identify assets placed in service in prior years that may be eligible for additional depreciation not previously claimed. Most depreciation issues can be corrected through automatic accounting method changes.
For example, consider the following possible actions:
- Conduct a cost segregation study for previously constructed or purchased real property.
- Review prior capitalized repairs to determine if they can be expensed.
- Determine whether prior assets may be eligible for bonus depreciation that was not claimed, or if they may be eligible for shorter depreciation lives than are currently being used.
The bottom line:
Accelerating depreciation deductions often is one of the most lucrative accounting method change opportunities. It's now even more critical, because making the change in any tax year after 2017 will not achieve the permanent tax rate savings discussed above.
Retirement plan payments
Taxpayers have a lot of flexibility when it comes to deducting pension plan and other qualified retirement plan payments because they often are able to choose the year in which those payments will be deductible. In order to deduct a retirement plan payment in 2017, you'll generally need to make a payment by Sept. 15, 2018 and report the payment on your 2017 pension plan return. Consider taking steps to allow 2018 payments to be deductible in 2017, or consider making extra payments. These payments do have real implications for the plan itself, so broader considerations also must be taken into account.
The bottom line:
Pension plan payments may be one of the best ways to take advantage of decreasing tax rates because you can maintain a great degree of flexibility over the amount and timing of the deduction.
Taxpayers will want to closely review accumulated earnings in foreign subsidiaries to determine if planning opportunities may exist to minimize the repatriation tax.
Net operating losses and other tax attribute utilization
Some manufacturers may have losses, so taking advantage of decreasing tax rates may not seem possible. However, there are still opportunities. For example, a taxpayer may consider maximizing a net operating loss (NOL) in 2017 in order to carryback the NOL to obtain refunds of tax from higher-taxed years. This may be even more advantageous because NOL carrybacks are no longer permitted after 2017, and any losses generated in later years will be subject to more restrictive limitations.
The bottom line:
Taxpayers with NOLs or other attributes should closely analyze ways to maximize or utilize those attributes more efficiently in 2017 before the tax rates change and other loss limitations come into effect.
Fiscal-year C corporations
Fiscal-year C corporations get an immediate benefit from the reduction in the corporate tax rate because they receive a prorated tax rate. For example, a corporation with a March 31, 2018, year end will have a tax rate of approximately 31.5 percent on all income generated during that year (9/12 months at 35 percent + 3/12 months at 21 percent).
Fiscal-year corporations have much more planning available to them than do calendar-year corporations because they still have time to take certain actions before their year end. These corporations should closely scrutinize all typical deduction acceleration and income deferral techniques to determine how to maximize savings.
The bottom line:
Fiscal-year corporations have more time to perform normal year-end planning, which is much more powerful in a decreasing tax rate environment.
Territorial tax system
Tax reform reshapes the entire U.S. taxation system as it relates to foreign activity through, among other items, the adoption of a “territorial” tax system. To make the transition to this new system, earnings that have been deferred in foreign subsidiaries will be subjected to a one-time repatriation tax, 8 percent for earnings held in cash and 15.5 percent for all other earnings, payable over up to eight years. There may be opportunities to manage the amount of earnings subject to this tax by closely reviewing the historical activity of each foreign subsidiary, and in some circumstances, making tax accounting method changes to minimize those earnings.
The bottom line:
Taxpayers will want to closely review accumulated earnings in each foreign subsidiary to determine if planning opportunities may exist to minimize tax. This process can be time consuming and should not wait.
Manufacturers shouldn't wait
These six planning items represent only the tip of the iceberg. And, the window in many cases is short — some of these actions will take time to execute. Begin assessing the impact tax reform will have on your manufacturing business immediately to start making decisions about the right strategies to pursue.
As always, if you have any questions, feel free to give us a call.