TCJA Impact on the Manufacturing Industry
The Tax Cuts and Jobs Act (TCJA) includes many changes and contains many favorable tax breaks for businesses. A number of tax breaks were eliminated or reduced in order to make room for other revisions. With most of these provisions going into effect for the 2018 tax year, it’s especially important for those in the manufacturing industry to take a closer look at how some of the new changes may impact their companies.
Reduction of corporate tax rate
One of the most notable changes in the TCJA is the reduction of the corporate tax rate from 35 percent at the highest end to a flat 21 percent rate. Additionally, the corporate alternative minimum tax (AMT) was repealed.
It’s important to note that the Domestic Production Activities Deduction (DPAD) was repealed. The DPAD was a tax incentive for businesses that manufactured property at least partially within the United States. Manufacturers who previously claimed this deduction will likely make up the difference by the reduction in overall tax rates.
Manufacturers that acquire and place qualifying assets in service after September 27, 2017, and on or before January 1, 2023, can expense 100 percent of the cost. Under the TCJA, qualifying property includes both used and new assets. This provision should encourage more capital spending and drive demand for manufactured items.
New 20 percent deduction for pass-throughs
Pass-through entities may qualify for a new 20 percent deduction on qualified business income under the new tax law. Also referred to as the QBI deduction or the Section 199A deduction, this deduction applies to income from partnerships, S corporations and sole proprietorships. Taxpayers are generally entitled to a 20 percent deduction for the lesser of qualified business income (QBI) or taxable income. However, certain “specified services businesses” may not be eligible for this deduction.
Limitations on business interest deductions
Prior to the new tax legislation, business interest was generally allowed as a deduction. Beginning with the 2018 tax year, every business is generally subject to a disallowance of a deduction for net interest expense in excess of 30 percent of the business’s adjusted taxable income. Post TCJA, the business interest expense is limited to the sum of:
- Interest income for the year, plus
- 30 percent of adjusted taxable income, plus
- Floor plan interest
Interest income means the amount of interest allocable to the trade or business. It does not include any investment income, which pass-through entities could have.
The business interest expense limitation does not apply to taxpayers with average annual gross receipts of $25 million or less (an average of the three-tax-year period ending with the prior tax year).
Net operating losses
To help offset the reduction of the corporate tax rate and pay for the qualified business income deduction, the new tax law limits net operating losses (NOLs). Prior to the TCJA, NOLs could be deducted in full to offset current year income. They could also be carried back two years to generate refunds from years when you previously paid taxes.
Under the new tax law, NOLs generated in 2018 and later can only be used to offset 80 percent of taxable income. This means that even in a year when NOLs are available in excess of current-year income, you would pay tax on 20 percent of your income, even though you still have a loss carryforward to the next year. Additionally, the two-year carryback period is no longer allowed. However, NOLs can now be carried forward indefinitely. If your manufacturing company sees great fluctuations from year to year, this change could impact your business.
Other considerations for manufacturers
Sales tax emptions. An often-overlooked tax exemption for manufacturers deals with how their materials are sourced. In Missouri, for example, a sales tax exemption exists for electrical energy used directly in manufacturing if the raw materials used in processing contain at least 25 percent recycled materials. Every state has different laws, but it’s worth researching what the applicable laws in your state are, and if exemptions like this are something your company could take advantage of.
IC-DISC. The IC-DISC export incentive is a provision for U.S. domestic companies that allows income related to export sales to be taxed at a lower capital gain rate. To take advantage of this export incentive, a company’s products must be manufactured in the U.S. and exported from the U.S. Also, 95 percent of IC-DISC gross receipts must be qualified export receipts and 95 percent of assets must be qualified export assets.
R&D credits. Under the TCJA, lower corporate tax rates might suggest that credits against tax, like the R&D tax credit, would be less valuable since corporations would likely have lower taxes to offset. While this could be the case for some businesses, the value of R&D tax credits may increase as a result of the lower rates. R&D tax credits can be calculated by one of two methods: the regular method or alternative simplified method. Both methods require an incremental increase in qualified research. Expenses connected with the research must be eligible research and experimentation (R&E) expenses under Section 174.
If you’re a manufacturer with questions about how the new provisions in the TCJA might impact your business, please reach out to us to schedule a meeting.