Manufacturing: Valuable Tax Planning Opportunities in a Time of Financial Uncertainty
By Edita Vysockyte, Director, Tax & Business Services
At a time of financial uncertainty when many manufacturers are wrestling with the economic slowdown imposed by COVID-19, it is very important to explore some of the opportunities available for businesses that could provide a valuable tax benefit. There are a few recent changes, as well as previous opportunities, that should be considered by manufacturing companies to plan for 2020 year-end and future years.
R&D Tax Credit
The Research and Development (R&D) tax credit is one of the most significant incentives in the U.S. tax code. R&D tax credits are not only about researchers in the lab trying to find a cure for the virus. As this credit has broad application, diverse manufacturing companies are working on improving their products or developing new processes which could qualify for this credit. Credit eligibility could help many businesses, especially manufacturing companies, to replenish cash spent on innovating and improving.
The federal R&D tax credit effectively allows a credit of up to 10% of eligible expenses. The federal credit can be utilized to offset income tax or, if eligible, employer payroll taxes. Any unused credit can be carried back one year and forward up to 20 years. There is no maximum amount of credit which can be generated as the credit is a function of eligible expenditures. Certain eligible companies may also have an opportunity to amend the prior three years of returns in order to claim credits retroactively. Keep in mind that the credit is only available for R&D expenditures incurred in the United States.
In addition to the federal credit, more than 30 states also provide an R&D tax credit to reduce taxable income.
Of necessity, many companies are developing new processes and workarounds in response to the coronavirus, in order to keep their employees and customers safe and to comply with government regulations. It is important to know that companies can qualify for an R&D tax credit if they design, develop, or improve products and processes for internal use, as well as for sale to customers.
Net Operating Losses under the CARES Act
To aid businesses during the pandemic, lawmakers enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which allows companies that incurred net operating losses (NOLs) in 2018, 2019 or 2020 to carry back the losses to each of the five tax years preceding the tax year of such loss. The CARES Act also amended (temporarily) the limitation that NOLs could be used to offset no more than 80% of taxable income. This relief can be beneficial to many manufacturers and would create an immediate cash flow for many businesses.
While provisions allowing the carry back of NOLs can be very beneficial for many businesses, there may be unintended consequences for some taxpayers. Companies with controlled foreign corporations have to carefully consider the interplay of NOL carrybacks with other Internal Revenue Code (IRC) provisions, especially the transition tax imposed under IRC Section 965. Without making a proper tax election, the refund expected as a result of carrying back NOLs may be applied against remaining 965 installment payments instead of providing the taxpayer a true refund. Companies should also consider the effect of carrying back NOLs on foreign tax credits, R&D credits, and AMT liability.
Depreciation Provisions under the CARES Act
The CARES Act corrected an error in the Tax Cuts and Jobs Act of 2017, related to the life of qualified improvement property. Qualified improvement property refers to any improvement made by a taxpayer to an interior portion of commercial property. As a result of the CARES Act, this property is now classified as 15-year property eligible for bonus depreciation. The change applies retroactively to property placed in service in 2018 as well, which may result in amended return opportunities.
This is an important planning opportunity for companies considering buying new equipment or planning to remodel facilities. Manufacturers can maximize depreciation deductions in order to lower 2020 taxes or increase NOLs for a potential refund or carryback opportunities.
Other Tax Planning Opportunities and Benefits for Manufacturers
- Excess business loss rules related to pass-through entity owners have been suspended.
- Business owners who have losses from pass-through manufacturing businesses may also be able to carry them back for refunds.
- More business interest expense is allowed. The adjusted taxable income percentage used to calculate the deduction limitation pursuant to IRC Section 163 increased from 30% to 50%. In addition, since the economic problems caused by the coronavirus are expected to produce lower taxable income in 2020 than in 2019, the IRS will allow taxpayers to use the 2019 adjusted taxable income to determine the limit in 2020.
- The corporate charitable deduction limit was increased from 10% of taxable income to 25% of taxable income for 2020. The individual limit was increased to 100% of taxable income.
As manufacturers continue to navigate through the current economic uncertainties and consider the potential tax saving opportunities and benefits, it is very important to note the complexity of the IRS code. It is imperative to consider the overall impact of applying various strategies to a company’s current tax profile and to model out potential tax savings to determine how these strategies interplay with different sections of the code. Seek out your Marcum tax professional for such guidance.
Coronavirus Resource Center
Have more questions about the impact of the coronavirus on your business? Visit Marcum’s Coronavirus Resource Center for up-to-date information.