As the pandemic continues, manufacturing businesses have faced many issues. On top of reduced revenue, layoffs, and other unforeseen problems, another year of preparing for the potential tax burden is upon each business. This article will discuss tax-saving opportunities and credits applicable to the manufacturing industry to consider when consulting with your tax advisor.
Important Tax Saving Opportunities for Manufacturers
As we approach another tax season full of various filing requirements, businesses need to know any tax savings opportunities that may arise from the previous year’s operations. Though many tax planning instances are on a case by case basis, below are a few common ones that may apply to a typical manufacturing company:
- Net Operating Losses Carrybacks
The CARES Act created the ability for taxpayers to once again carryback Net Operating Losses (NOLs) to offset taxes paid in the previous five years. This includes NOLs that occur in 2020 can be carried back to offset taxes paid in any of the last five years. Upon election in the individual’s tax return, 2018-2020 NOLs can be carried forward to offset future taxable income.
- Cost Segregation Study
These studies can be a valuable tax-saving strategy for manufacturing companies. A cost segregation study is used to identify all costs in a manufacturing facility that has a life of less than 39 years. If the operating company does not hold the facility, a study can still apply to a related party holding company.
- Tax Accounting Methods
An election can be made in the current year or prior tax returns (with an amendment) to make an accounting change. Both require consent from the Internal Revenue Service requested via Form 3115. A change regarding previous years may require a prior period adjustment based on the type of accounting change.
The two main tax planning goals to achieve in an accounting change are:
- Income deferral
Common types of income deferral include advanced payments, deposits, and deferred revenue, long-term contracts, installment sales, and like-kind exchanges
- Expense acceleration
Common types of expense acceleration include treatment of prepaid expenses, software development costs, fixed assets, and other opportunities
- Income deferral
It is important to continuously examine how a manufacturing company is accounting for income and expenses for tax purposes. It is crucial to weigh the benefits and costs of changing accounting treatment.
Tax Credits for Manufacturers
Many activities manufacturing companies participate in may qualify them for tax credits. Tax credits are most commonly derived from operations, employees, and facilities. It is important to understand each business aspect to know if eligible for the many tax credit opportunities. Here are the most common tax credits that may apply to a manufacturing business.
- Research and Development (R&D) Tax Credit
This federal tax credit was introduced in 1981. The credit is an incentive for operating businesses to invest in research and development activities. In the manufacturing industry, these costs are most often used to increase growth and competitiveness. The maximum credit allowed is 13% of eligible expenses spent on new and improved products and processes.
The costs must meet the following categories of new or improved to the company. These include technological in nature, elimination of uncertainty, and must go through a process of experimentation. The most common activities that manufacturing companies participate in that may be eligible for the credit are:
- Sales time – quoting, job requirements
- Design meetings – staff working together towards innovation
- Product design – blank layouts, toolmaking, documentation, quality checks, trial runs
Note: Manufacturing activities that improve an existing product or process may qualify for this tax credit.
- Payroll Tax Credits & Deferrals
The CARES Act provides a refundable payroll tax credit for 50% of wages paid to employees during the COVID-19 crisis. The credit applies to wages paid after March 12, 2020, and before January 1, 2021.
The maximum amount of wages eligible for the credit is $10,000 per employee, which results in a maximum credit for each employee of $5,000. If the manufacturing business experienced a government order resulting in business limitations, reduced sales from the prior year, travel, etc., the credit could be claimed. The credit may be claimed immediately by reducing the amount of payroll taxes. The credit is then used to reduce the employer portion of social security taxes.
Note: Not eligible if a Payroll Protection Program (PPP) loan was utilized.
- Work Opportunity Tax Credit
The Work Opportunity Tax Credit (WOTC) was initially eliminated but has been reactivated and is now extended through 2020. The credit is a result of hiring specific disadvantaged “target” employees. People included under this category are:
- Qualified IV-A recipients
- Qualified veterans
- Designated community residents (DCR)
- Vocational rehabilitation referrals
- Summer youth employees
- Supplemental nutrition assistance program (SNAP) recipients
- Supplemental Social Security Income (SSI) recipients
- Long-term family assistance recipients
- Qualified long-term unemployment recipients (added when the PATH Act took effect)
The WOTC is equal to 40% of the first $6,000 of wages for each employee, which equals a maximum credit of $2,400 per worker. The credit is increased for disabled veterans. Instead of $6,000, it is based on $24,000 of wages, which equals a maximum credit of $9,600 per worker.
- Empowerment Zone Incentives
Manufacturers operating in designated “empowerment zones” continue are eligible for this tax credit. The credit is equal to 20% of the first $15,000 of employee wages, maximized at $3,000 per worker. Manufacturing companies can use the WOTC in conjunction with the Empowerment Zone credit but cannot double up wages used per employee.
A credit requirement is that the employee must also live in an empowerment zone along with the business. This can be verified by the address on the employee’s W-2. For empowerment zone mapping, most states, counties, and cities are made available through a government website search.
- Family & Medical Leave Credit
Businesses, especially in the manufacturing industry, have found it beneficial to offer employees paid time off. The credit requires that employees receive at least two weeks of paid time off and pay at least 50% of regular earnings during the time off. The credit ranges from 12.5% to 25%, depending on the level of pay. The maximum time allowed to use to calculate the credit is 12 weeks per worker.
Tax Deductions for Manufacturers
The CARES Act and previous tax reform have altered and eliminated many deductions previously available. Below are some of the most common deductions based on the current tax environment:
- Qualified Business Income (QBI) Deduction
Qualified Business Income from pass-through entities (sole proprietorships, partnership, or S-corporations) are generally eligible. The deduction is maximized at 20% of qualified business income. This deduction can be limited depending if the business operates as a specified service or trade business. If the individual’s taxable income exceeds an income threshold, the deduction is also subject to additional limitations.
The three general categories that determine the deduction are the business’s qualified business income, W-2 wages, and the business’s qualified property’s unadjusted basis. Any one of these items can be analyzed before year-end to maximize the deduction through proper tax planning.
- Accelerated Depreciation
- Section 179 is eligible for up to over $1 million of qualifying property placed in service in the tax year. Note: Minnesota recently conformed to the federal treatment of section 179 for the years 2020 and after.
- Bonus depreciation for 100% of qualified property is eligible through 2022. From years 2023 – 2027, the deduction will reduce until no longer available.
- The CARES Act provided a technical correction from Tax Reform in December 2017. Qualified Improvement Property (QIP) is now a 15-year, bonus depreciation eligible property. QIP consists of interior, non-structural improvements to commercial buildings added after the buildings were initially placed in service.
- Section 179D Energy-Efficient Commercial Property Deduction
This deduction is eligible for manufacturing companies that directly or indirectly own a newly constructed building or improved an existing building. To claim the deduction, the new building or improvements must invest in one of the three energy-efficient categories:
- Lighting – construction or improvements to building lights for energy efficiency
- HVAC – relating to energy-efficient systems
- Building Envelope – energy-efficient construction or improvements to walls, floors, roofs, fenestrations, and doors
The calculation of the deduction is based on the square footage of a new building or improvements. The deduction provides a $1.80 per square foot of the energy-efficient space. Each category above can obtain a $0.60 deduction. To qualify for this deduction, a building must be certified by a qualified third-party and compared to ASHRAE Standards.
Other Opportunities for Consideration
There are several other opportunities for a manufacturing business to consider. Based on some common business themes relating to the manufacturing industry, below are a few additional items to consider when looking for savings in the coming year:
- Review Terms of Current Contracts
- Line of credit or other long-term debt agreements. Interest rates have decreased in 2020. If you have a minimum interest rate on any variable contracts, it is a good idea to review and refinance. Look to extend the length of renewal. A longer renewal period can help freeze pricing and provide assurance to a bank to maintain the relationship. Many companies make the mistake of negotiating yearly, which leads to lower prices, but could risk damaging the relationship with the bank.
- Similar to banks, look to renegotiate terms with your vendors. Items to focus on can be discounts for early payments, extended payment terms, or payment allowance with a credit card.
- Improve Inventory Management
Proper inventory management, especially in a manufacturing company, is a great way to improve cash flow. Removing excess or slow-moving inventory can be a quick way to reduce waste and generate cash flow. Initial fees may be incurred, but the long-term cash savings can outweigh the costs.
Manufacturing companies should also analyze the amount of inventory needed for operations. Reducing the overall value in inventory may result in a simple improvement in cash flow. Also, businesses should consider updating purchasing procedures or any other inventory processes.
- Sell Assets
Review each fixed asset on an annual or more frequent occurrence to determine if any non-productive assets can be sold. Non-productive are commonly old assets that have not been used for a while or items no longer required by current operations.
Are you confident you are doing everything to minimize taxes for your manufacturing business?
As you push your shop floor to run faster, leaner, and more efficiently, you need people who can help you apply the same principles to your business office. Schedule a consultation with a Smith Schafer Manufacturing Expert to determine tax-saving opportunities for your company. We work with approximately 100 Minnesota manufacturing companies helping them grow with accounting, tax, and consulting solutions.