The most comprehensive tax reform legislation package in more than 30 years is now law, and it will impact businesses of all shapes and sizes in nearly every industry. There are a number of provisions that will have a significant impact on manufacturers and distributors. Therefore, company leaders need to work closely with their tax advisers to assess these provisions and understand their business impact.
Tax rate reductions promise to benefit industry
The headline-driving piece of the new law is the tax rate reductions.
The law reduces the top corporate tax rate from 35 percent to 21 percent, and this new rate is effective in 2018. The law also removes the lower graduated corporate tax brackets and adopts just one 21 percent flat rate for corporations. This is a significant reduction in the tax rate and should reduce manufacturers and distributors’ federal corporate tax liabilities in the coming years. It will likely make U.S. manufacturers more competitive with manufacturers in other countries. In addition, the tax bill also repeals the corporate alternative minimum tax beginning in 2018.
Congress spent significant time and effort trying to address how much tax relief (and in what form) to provide to owners of pass-through businesses (partnerships/LLCs, S corporations and sole proprietorships). In the end, Congress included a 20 percent deduction for “qualified business income,” but also added a limitation to this deduction that takes into account:
- 50 percent of the wages paid by the business;
- 25 percent of the wages paid by the business plus 2.5 percent of its cost of property used in the business.
The greater of these two numbers is compared to 20 percent of a company’s qualified business income. A company’s deduction is the lesser of these two numbers.
This is a complicated provision, but the bottom line is that it will provide a tax incentive for many manufacturers and distributors, small or large. In addition, the new formula makes this new 20 percent deduction available for manufacturers or distributors that have limited wage expense but are very capital intensive.
Changes to key provisions will impact companies
The law makes 100 percent bonus depreciation available for property that a company acquired and placed in service after Sept. 27, 2017. This is one of the few provisions that applies for the 2017 tax year, and, as a result, manufacturers should evaluate all their 2017 capital expenditure additions. Further, this deduction applies to property that is only new to the manufacturer or distributor. Therefore, used property acquired by the company could qualify for the 100 percent bonus depreciation. Previously, the bonus depreciation rules did not permit used property to qualify for this deduction. In addition, the Section 179 expensing rules were expanded up to $1 million (which begins to be phased out once overall additions exceed $2.5 million) beginning in 2018. The definition of Section 179 property was also expanded.
The law includes a new family and medical leave tax credit, which applies to the tax years 2018 and 2019 and is available to companies that pay their employees during family and medical leave. If an employer provides at least two weeks of family or medical leave per year to a full-time employee, then a tax credit of 12.5 percent of the wages paid during the family leave is available, as long as the wage paid during the leave is at least 50 percent of the employee’s normal wage. The law increases the credit if a company pays the employee a wage above the 50 percent limit.
While expanded bonus depreciation and Section 179 expensing and the new family and medical leave tax credit could benefit manufacturers and distributors, the law does limit the ability of businesses to deduct business interest expense. The new rule limits the deductibility of business interest to 30 percent of adjusted taxable income, which is defined as the taxable income of the manufacturer. However, it excludes any business interest income of the company, any net operating loss of the company, and any depreciation or amortization deductions of the company.
The 30 percent deduction applies to manufacturers that are corporations, and there are special rules for this provision that apply to pass-through businesses and their owners. Also, any disallowed interest expense under this 30 percent provision is carried forward indefinitely. Finally, this provision does not apply to smaller manufacturers, as there is general exception for a “small business” (defined as a business with gross receipts of less than $25 million).
Important tax incentives retained by law
In addition to analyzing all the changes made by the new tax law, it is also worth noting the several important tax incentives that were not eliminated as part of the final legislation. There was speculation and discussion that the following items could be removed or limited in exchange for tax rate reductions, but they were not part of the final tax bill, which is a positive for manufacturers and distributors.
LIFO Inventory. The “last in, first out” inventory method was preserved. Many manufacturers with rising costs have utilized LIFO over the years to provide much needed capital for their business.
Research (R&D) credit. The research credit has been increasingly used by manufacturers as they strive to develop new products and processes to stay competitive in the marketplace. The law did not alter the credit in any way. As a result, manufacturers should continue to analyze and document their research efforts and seek to take full advantage of this key credit.
IC-DISC. The IC-DISC offers a tax incentive for manufacturers that export their products out of the U.S. This opportunity for tax savings was not changed by the law, but the net potential tax savings are slightly less due to the new lower tax rates.
The law could also have a significant impact on manufacturers and distributors that have extensive international operations or holdings. There were wholesales changes in the overall tax regime for international tax matters, and several of these changes are phased in over a number of years. Any affected manufacturers or distributors should carefully review and address the tax impact these changes may have on their businesses in near-term and beyond.
Overall, the impact of the new law should be favorable for the industry. However, given the multitude of provisions that will directly impact manufacturers and distributors, it’s important that company leaders work with their tax advisers to closely evaluate the law and identify relevant new requirements as well as ways the law can benefit their businesses.