Positive sentiment in manufacturing is at an all-time high—with numbers in hiring, wages and investment in capital all reflecting the optimism.
For those manufacturers looking to maximize their tax savings in this calendar year, tax advisers say there is opportunity to reinvest now in areas such as equipment purchases—and there are other potential savings to be had in R&D projects and used equipment purchases.
Learn More About The Section 179 Deduction
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Is now a good time to buy that new 5-axis CNC machine or other major manufacturing equipment you’ve been eager to get into production?
“The answer to that question is always: Don’t let the tax answer sway you one way or the other,” says CPA Brian Kitchen, a director of tax strategies who specializes in the manufacturing industry for Kreischer Miller. “It should always be a business decision first. But if there is an opportunity to reinvest in the company with a new piece of equipment that may be faltering or may need to be repaired—or maybe it’s been repaired dozens of times already—the thought of acquiring a new piece of equipment by cash or financing qualifies for a tax incentive.”
How the TCJA Is Impacting Tax Reform in Manufacturing
Under the 2017 U.S. Tax Cuts and Jobs Act, or “TCJA,” companies can now expense the full cost of equipment at 100 percent for federal taxable income—whereas in the past, equipment expenses could only be deducted at 50 percent in the first year and were depreciated over the course of five to seven years, explains Kitchen. Through 2023, companies can continue to expense the full cost of capital equipment at 100 percent rates. For example, if a manufacturer spends $500,000 on new machines and software and simulation technology, that manufacturer can deduct that total amount in the year it is acquired.
“That could be significant tax savings, as indirectly, the government is effectively subsidizing that asset acquisition via not having to pay taxes on those dollars,” says Kitchen. It means more money in the hands of manufacturers to invest for growth—rather than cost.
Is this a good thing for manufacturers? With the tax reform act, corporate rates have been slashed from 35 to 21 percent and are expected to generate tax savings of as much as $261.5 billion for the manufacturing industry, per the Penn Wharton Budget Model. John Livingstone, a tax principal for industrial products at PwC, thinks it’s advantageous for the manufacturing sector. In his PwC blog post, “Manufacturers and Tax Reform: Seize the Opportunities,” Livingstone writes:
“With more cash on hand, manufacturers have the opportunity to modernize their plants and processes. They can buy state-of-the-art equipment, boost IT infrastructure and expand digitization of manufacturing facilities and supply chains. They also can rethink how they want to allocate capital and grow the business.”
Under the Radar: Used Manufacturing Equipment Gets a Boost
It used to be that the bonus depreciation tax benefit rewarded only those companies that bought new equipment—but many manufacturers also buy or lease used manufacturing equipment. Buyers of used machining gear also have something to celebrate.
“New tax laws allow bonus depreciation on used property, removing the restriction that required you to be the original purchaser,” writes Kerry Defler, a lead tax partner in manufacturing and distribution for Aprio. But there is a timetable. “This additional expensing is currently set to reduce by 20 percent each year starting in 2023 and expire completely after 2026,” notes Defler.
Want the inside scoop on tax reform? Read “Better MRO Asks Experts to Weigh In on Tax Reform Opportunities for Manufacturers.
Don’t Forget About the Value of R&D Tax Credits
Another under the radar area for a bit of potential tax relief comes in the form of research and development credits, explains Kitchen. R&D, as it’s commonly referred to, has not disappeared, nor has its tax credit diminished for manufacturers.
“If a company is buying equipment but that equipment is being used for a new focus area—such as new product development—they are likely using research and development efforts to make that happen,” says Kitchen. “That new piece of equipment could be vital to that process. And so a good amount of the costs associated with product development could be eligible for that research and development tax credit.”
In a machining context, perhaps a machine shop decides to prove its ability to manufacture aerospace or medical parts—and invests in new equipment. There is a fair amount of trial and error and quality testing to bring parts to specification—and also to an output level that proves profitable.
“It isn’t only a deduction for the equipment, but it’s also a credit on top of the deduction,” says Kitchen. “The credit lowers your tax liability.”
As an example, Kitchen says that he has seen companies that spend around $100,000 in R&D typically yield a 5 to 10 percent tax credit—with 10 percent being the highest end. And it’s not just equipment that is potentially eligible: It’s also the labor involved in the R&D project that can be part of the qualifying expenses, according to Kitchen.
“If it’s a machine shop, they’re likely going to have a fair amount of scrap in the R&D process,” says Kitchen. “Typically, companies are not getting their new products or parts right the first time. Maybe the fifth time. There is a lot of trial and error, and so this R&D credit in manufacturing can be profound.”
“If you can save a tax dollar today and perhaps reinvest in the company and generate more revenue, that’s usually a win. But it varies from taxpayer to taxpayer.”
The Time Value of Money
Do these immediate “accelerated” tax savings benefit manufacturers, or does the former way of depreciating costs over time have its own set of benefits that companies can continue to use?
“It does depend, but I always look at it and ask this: If you can save a tax dollar today and perhaps reinvest in the company and generate more revenue, that’s usually a win,” says Kitchen. “But it varies from taxpayer to taxpayer.”
To help determine the best financial equipment investment strategy that is aligned with your company’s goals, Kitchen advises that your tax adviser run time value of money calculations with you to find out what makes the most sense for your business in the timing you need. It really will depend on your situation.
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