Savvy manufacturers are always looking for ways to increase revenue and minimize costs. One of the biggest cost factors is taxes, but identifying all possible credits and deductions can be tricky. As 2018 begins, manufacturers concerned about 2017’s tax bill can jump-start the process of minimizing future tax costs by discussing their operations and strategy with their CPA. Below are a few common scenarios, questions, and some general answers; we often find these topics to be useful jumping-off points as we explore areas specific to each company’s unique situation.
No. 1 - Inventory Write-Down
I have inventory that I can’t sell at full price, but would like to get as much value out of it as possible. When can I write it off?
Goods become unsalable at normal prices due to damage, imperfections, shop wear, changes in style, and odd lots, as well as other factors. You should write down these goods for the tax period in which they lose value, but there are a couple of caveats to be aware of: First, you must hold the goods for sale to the general public at the reduced price within 30 days of the end of the tax period. Also, for any inventory written down to zero, you must physically dispose of it in order to claim the write-down.
No. 2 - Bad Debt
I’m in dispute with a customer and don’t think I’ll get half the money he owes me. Can I deduct that amount for tax?
This scenario is common and, yes, you can generally deduct uncollectible amounts. As with write-downs, you should claim bad debt for the tax period in which it becomes uncollectible. You must also (1) have sufficient evidence to prove that the debt is, in fact, uncollectible, and (2) indicate in your books that the charged-off amount is a worthless asset.
No. 3 - IC-DISC
I sell a significant amount to customers outside the U.S. Is there a way I can use that fact to reduce my tax burden?
Yes, you can, in the form of an Interest Charge Domestic International Sales Corporation (IC-DISC), which is the last remaining tax incentive for export manufacturers. A DISC is a “paper company” set up as a C corporation with a DISC election. The primary benefit is a permanent tax savings achieved by converting ordinary income to capital gains (currently a difference of approximately 15% depending on circumstances). While any sized company may set up a DISC, the structure is most beneficial for closely held companies with few owners. Work with your CPA to set it up and understand how it works to gain the maximum benefit.
No. 4 - Deferred Revenue
Someone paid me in advance for an order I won’t fulfill until next year – or, I’m selling gift cards during the holiday season. Is there any way to defer tax payments accordingly?
Yes, the IRS provides several opportunities to defer paying tax when you receive cash that qualifies as a “deferred payment.” Generally, taxpayers are able to defer paying tax for a full year past the year in which they received the cash; in certain circumstances, taxpayers can defer paying the tax for even longer.
No. 5 - Prepaid Expenses
I have to pay for next year’s insurance in December. Can I deduct all of that cash payment now?
Yes, in some cases you can deduct the cash outlay in the year you make the payment rather than over the next 12 months of insurance premiums. Specifically, eligible expenses include those for which economic performance depends on payment. Check with your CPA to see if this rule applies to your situation.
No. 6 - Nexus for Goods Delivered Via Third Party
I use Fulfillment By Amazon (FBA) services to deliver goods across the country. I am exempt from paying local taxes in each state I deliver to, right?
Many companies use similar services because of the convenience, but establishing the tax responsibility can be tricky. Unfortunately, when you use services like FBA, you do potentially establish a tax filing requirement in the states where the service holds your goods. As each state creates its own rules on what can require you to file any number of tax returns, this can be a challenging area to navigate. If this is the first you have heard of this, it is important to know that many states recently extended a joint tax amnesty program for those companies out of compliance as a result of using FBA. If you missed this opportunity, it’s possible another may be offered; stay alert and work with your CPA to negotiate this issue and seize on any future amnesty programs.
No. 7 - Talent
I make it a point to hire veterans. I would do it regardless, but I’m wondering if I can get a tax advantage for it?
The Work Opportunity Tax Credit (WOTC) is a tax credit based on wages paid to employees from targeted groups such as veterans, the long-term unemployed, ex-felons, and food stamp recipients, among others. If you use a payroll provider like ADP, it’s likely they offer a service to gather the necessary documentation to claim the credit. Your CPA can also calculate the credit using IRS Form 5884.
No. 8 - Capitalization Policies
Do I have to capitalize every stapler or trash can? Where else can I squeeze more tax deductions?
This will be different for each company. You should establish a written policy for the dollar threshold at which you will capitalize and track “capital assets” and when you will simply expense them in the current period. The IRS currently allows taxpayers to set that threshold as high as $2,500 per item (or $5,000 per item in certain situations) without challenging their treatment. This is in addition to generous “accelerated depreciation” methods such as §179 expensing and “bonus” depreciation.
Tax preparation is a two-way street. CPAs will always look for all relevant deductions, but no one knows your business like you do; knowledgeable company representatives can be highly valuable when they are proactive in questioning areas that might help to reduce their tax bill.
This article is not intended to provide legal or tax advice. Tax strategies are highly dependent upon the facts and circumstances of each tax payer and no two situations are exactly alike.
Mike Fitzgerald and Brent Hendricks are both Tax Partners at EKS&H.