At the end of last year, Congress passed and the president signed into law the most comprehensive reform of the tax code in over a generation. From reductions in corporate and individual rates to changes regarding popular incentives, the implementation of the new bill is set to create a host of new opportunities for manufacturers.
To better understand the new law, we’ve offered a few highlights on the opportunities that exist to add valuable dollars for reinvestment. We’ve also provided a few specific strategies and tax incentive changes businesses should consider to put themselves in the most tax efficient position.
Reduced Tax Rates for Corporations
A central piece of this legislation is the dramatic reduction of the corporate tax rate from 35 to 21 percent and the complete repeal of corporate AMT. Both modifications will provide unprecedented tax relief for manufacturers organized as C corps, giving them additional dollars and the ability to expand factories, reinvest in new equipment, hire new employees and pour money into improving their products and services.
Best of all for manufacturing C corps, the corporate provisions are all permanent, providing these businesses much needed certainty when evaluating their future investments.
Benefits for Pass-Throughs
In addition to lowering the corporate rate, the new legislation provides equally critical relief for pass-throughs by reducing individual tax rates, curbing the number of businesses hit by AMT and through a new deduction on qualified business income (QBI).
Lower Individual Rates
While the legislation maintains the seven tax bracket structure for individual tax rates, the new law reduces the rates for several brackets while dropping the new top rate to 37 percent. As you can imagine, this is extremely beneficial for small and mid-size manufacturers, the vast majority of which are setup as pass-through entities and are taxed at the owner’s individual rate. There are additionally some complex new rules that business taxpayers should review with their CPA.
However, considering the more significant reduction in rates for C corps, many manufacturers may want to explore their options with regard to their chosen entity type (we’ll cover this in more detail later).
The new law curbs who is hit by AMT on the individual side by raising the income exemption levels – $70,300 for single filers and $109,400 for joint filers. This modification opens the door for more businesses to be able to use specific credits and incentives to lower their effective tax rate (specifically, the Research and Development Tax Credit).
Additionally, the new law also changes the exemption phase out which doesn’t kick in until the taxpayer hits $1 million in AMT income (or $500,000 if not jointly filling) – for reference, the original phase out began at $150,000. This means that taxpayers under the $1 million range will get the full $109,400 exemption.
Deduction for Pass-Throughs
Owners of manufacturing pass-throughs are likely to see significant returns from the new deduction on qualified business income.
For years, Congress has grappled with how to create tax policy that specifically provides relief for small businesses. Under the new section 199A deduction, taxpayers are eligible for a deduction of the lesser of their combined qualified business income or 20 percent of their taxable income. However, it should be noted that the deduction is subject to several limitations, including those related to W-2 wages. Click here for a full review of the deduction and its impact on manufacturers.
The main takeaway here is that pass-throughs will see real tax relief — the amount of relief will just depend on a number of different variables.
Choice of Entity Type: C Corp Vs. S Corp?
As mentioned above, with several new provisions in place, it may be advantageous for certain business owners to consider changing their entity type from an S Corp to a C Corp or to divide operations and assign them different tax entity status. However, there are a number of factors to consider prior to making the switch.
While C Corps are now taxed at a lower rate, they may be subject to double taxation, once at the new 21 percent corporate rate and once again should the owners pay dividends. For manufacturers that choose not to pay out dividends, but rather invest their new found savings back into the business, changing from an S Corp to C Corp may indeed prove to be the most attractive option.
Aside from reinvestment, there are other factors business owners should consider such as the cost of consultation fees with attorneys and accountants that will be necessary when changing business structure. Those fees could be higher than the anticipated savings themselves, thereby defeating the entire purpose of such a change. Additionally, bear in mind that if your S corp generates income of less than $315,000 a year, your company likely qualifies for the pass-through deduction, thus protecting the company from higher rates (and potentially removing the desire for an entity change).
Impact on Popular Credits and Incentives
Perhaps the most beneficial aspect of the bill for manufacturers is its impact on three popular tax incentives:
The new law allows companies to immediately expense the full cost of qualified property acquired and placed into service before 2023 and removes the requirement for taxpayers to be the original user of the property (so long as it is not acquired from a related person or entity).
This provision will phase down 20 percent every year after 2023 and eventually expire after 2027.
The new legislation allows businesses to immediately expense up to $1 million of the cost of certain depreciable assets acquired and placed into service during the tax year. The amount available for expensing is reduced by the amount that the cost of the assets exceed $2.5 million.
It bears noting that the choice of which of these new cost recovery provisions a taxpayer makes will likely depend on the nature and size of the asset. While certain assets will qualify under both provisions, the taxpayer can only choose one.
The R&D Tax Credit
One of the most valuable business tax credits, the R&D Tax Credit remains in place for the benefit of manufacturers. For the technical improvements made on the factory floor to improve the cost, speed, efficiency and environmental impact of a product (or the process used to make said product) a business can (depending on a number of different variables) receive six-figures or more in tax savings.
Now, due to the new tax law and its elimination of corporate AMT and curbing of the number of pass-throughs subject to individual AMT, one of the most significant hurdles to utilize the credit has been removed. As a result, even more manufacturers will be able to take advantage of this incentive.
With across the board rate reductions, new tax provisions and several beneficial modifications to popular tax incentives, manufacturers are poised to heavily benefit from this bill — now is the time for them to take advantage of these changes.