Better MRO Asks Experts to Weigh In on Tax Reform Opportunities for Manufacturers
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5:50 Minutes
We interview tax law and accounting experts to help you learn about the opportunities and options in the latest tax reform law.
What You Need To Know
To best take advantage of the new tax laws benefits—either in direct savings or investment incentives, manufacturers will want to assess their unique situations and then set strategic plans, suggest tax experts. Here’s what they say you need to know.
The U.S. Tax Cuts and Jobs Act, which cut corporate rates from 35 to 21 percent, is expected to generate tax savings of as much as $261.5 billion for the manufacturing industry, empowering companies to invest in capital equipment and create more jobs, according to the Penn Wharton Budget Model. Although some of its provisions are temporary, manufacturers now know what to expect for at least a few years, says Omar S. Nashashibi, founding partner of The Franklin Partnership LLP and head of government relations for One Voice, the advocacy program of the Precision Metalforming Association and the National Tooling and Machining Association.
“I recognize that some provisions will expire but compared to what manufacturers have had over the last several decades, we call that stability,” says Nashashibi. “Clients now have a window to plan capital expenditures over the next three to five years.”
John Livingstone, a tax principal at PwC for U.S. industrial products, agrees. The changes in capital equipment depreciation and expensing, in particular, should be considered strategically. “We now have a more attractive expensing provision that will last longer,” he says. “That provides a more affordable way for investing in capacity, upgrading, automating and digitizing where appropriate.”
The biggest benefits for manufacturing and metalworking companies can be divided into two broad categories: direct savings from tax cuts and investment incentives through changes in expensing, depreciation and accounting.
Lower Taxes for Every Manufacturer and Owner
The relatively straightforward 14 point tax cut for C corporations grabbed the headlines. The benefit calculation for S corporations, the most common structure for small and midsized manufacturers, is more complicated. A 2018 survey from One Voice, found 58 percent of companies with an average of 72 employees use the S corp designation [for more details, see our sidebar, “A Snapshot of the Middle Market”].
As pass-through entities, S corporations get taxes reduced on two levels, says Brian Kitchen, tax director at Kreischer Miller, which counts many mid-size and small manufacturers among its clients. S corp revenues pass to the owners, who then pay tax based on their individual rates. The new law lowered the highest individual tax rate by 2-plus points, to 37 percent from 39.6 percent. And certain pass-through entities including manufacturers will be able to deduct 20 percent from their income before applying tax.
Some S corp owners are considering becoming C corps to get the bigger tax rate reduction, but it’s not so straightforward, Kitchen notes. Many of his clients plan to hand over the business to the next generation or sell it at some point. “I’ve been getting text messages from clients asking if they should switch to a C corp,” he notes. “But I recently had a three-hour meeting going over with a client what it could mean. It’s really important for people to understand not only the immediate potential tax savings, but also the long-term consequences.”
A Shot of Adrenaline for Capital Investment
The law significantly expanded expensing and depreciation of capital investments. Limits on Section 179 expensing were raised from $500,000 to $1 million. In addition, companies can deduct 100 percent of the cost of equipment in the year it was purchased and put into service, including used equipment, which can reduce taxable income significantly. That not only encourages capital spending by manufacturers, but also juices the revenues of the manufacturers that make manufacturing equipment or components, Livingstone says.
Notably, this is one of the few provisions that are retroactive and can be applied to 2017 taxes. “If you acquired capital equipment last year after Sept. 27, you can expense 100 percent of it on this year’s taxes,” says Jim Brandenburg, tax partner at Sikich. Take that 2017 deduction if you can, he says, since it will be more valuable at 2017 rates than it will be at the lower 2018 rates.
"We now have a more attractive expensing provision that will last longer. That provides a more affordable way for investing in capacity, upgrading, automating and digitizing where appropriate."
There was also a provision that will benefit smaller players specifically. The new law raised the revenue limit for qualifying to use cash accounting from $10 million to $25 million, notes Kitchen. That means more companies are freed from using the accrual method of accounting, which requires them to pay taxes on accounts receivable and prevents them from expensing inventories.
In combination, these changes should prompt a wave of investments. In a survey by the National Association of Manufacturers, nearly 70 percent of respondents said tax reform would encourage their company to increase capital spending and two-thirds suggested that it would enable them to expand their businesses. Nearly 60 percent said that they would hire more workers. The cash infusion could also spur a wave of mergers and acquisitions. Small, niche companies might become acquisition targets of larger manufacturers, says Bryan Ball, vice president and group director of supply chain and global supply chain management practices at Aberdeen Group.
What’s your take? Talk to your peers in the community forum .
A solid strategic plan should enable companies to make the most of the temporary provisions. The expansion and acceleration of depreciation will be phased out starting in 2022. Individual tax rates are scheduled to rise to previous levels in 2026. The 20-percent deduction for pass-through revenue also ends then. Then again, things can be changed by future Congresses, so plan strategically, but act sooner rather than later.
And don’t forget to use a trusted tax advisor to help you. Although tax reform delivers many benefits for manufacturers, simplicity isn’t one of them. “You’ll pay less in taxes, but you won’t be filing your taxes on a post card,” says Nashashibi.
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Does the size of the company matter to the equipment deduction? Size meaning one employee(200,000/year revenue) vs 100 employees(2,000,000/year revenue).
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