Manufacturing and the TCJA

Manufacturing: What you need to know about the Tax Cuts and Jobs Act

Good economic times can be made even better by taking advantage of the Tax Cuts and Jobs Act.

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). Many would argue the TCJA is anything but simplification. Nevertheless, federal income tax laws likely won’t change significantly again for several years. Read on to see how the manufacturing industry can make good economic times even better by taking advantage of the TCJA.

The TCJA itself is more than 500 pages, and we’ll likely see at least that many more pages of guidance from the IRS in the coming months and years. Below are significant sections of the TCJA for the manufacturing industry. Here you can find a more comprehensive listing of provisions. Note that most of these changes are effective for years beginning after 2017 and before 2026.

Section 168(k) depreciation / Bonus depreciation

Section 168(k) depreciation – more commonly referred to as bonus depreciation – has been increased from 50 percent to 100 percent for qualified fixed assets available for service after Sept. 27, 2017, and before 2022. Note that you must not have committed to the purchase prior to Sept. 28 to qualify for 100 percent bonus. This removes tax considerations from the business decision on whether to buy used or new. Heavy highway and other capital intensive businesses will see large increases in tax depreciation and possibly tax basis losses. This may also lessen the pain of “coming clean” on any improper tax accounting methods that will increase taxable income.

Net operating losses

It’s likely a wise decision to generate tax losses where possible for 2017 since net operating losses incurred in years ending after December 31, 2017 may not be carried back. In exchange the carry forward period has been increased from 20 years to indefinitely. 2017 is the last year you may be able to carry back a loss to recover income taxes paid in 2015 and/or 2016. Since future tax rates will be less than 2017 rates, a lifetime tax savings may be earned by generating tax losses in 2017 to carry back and recover tax at a higher rate than will be available in the future. Furthermore, net operating losses arising in tax years beginning after December 31, 2017 may only offset up to 80 percent of taxable income. Consider the use of additional accrued bonuses, profit sharing contributions, installment sales and other special tax accounting methods to lower your 2017 and lifetime tax bills.

Trade or business losses

Net operating losses are not the only type of loss whose present value has been reduced with the TCJA. There’s a new hurdle to fully deduct current year business losses. Trade or business losses exceeding $500,000 for married filing joint taxpayers will be disallowed in the current year. This provision applies at the shareholder or partner level. It’s somewhat similar to limits on capital losses that are only available to offset up to $3,000 per year of other income types for individuals. Taxpayers with large salaries, investment or other types of income may still be forced to pay income tax even though their share of business losses exceeds their non-wage and non-business income. The excess will be carried forward to the next tax year and treated as a net operating loss subject to the restrictions discussed above. It serves in part to limit the current value of losses generated from large depreciation and other deductions.

Business interest expense

In exchange for 100 percent bonus depreciation, business interest expense may now be subject to limits if your average gross receipts exceed $25 million. The limit is initially set to 30 percent of taxable income before interest expense, depreciation, amortization and depletion. Beginning in 2022 the rate is modified to 30 percent of taxable income before interest expense only. Be mindful of this provision when determining the appropriate leverage for your company.

Section 199A / Pass-through deduction

TCJA repeals the domestic production activities deduction (DPAD) but puts a new deduction in place for sole proprietors, S corporation shareholders and partners referred to as the Section 199A or pass-through deduction. The calculation of this deduction can be complex and is beyond the scope of this article. It is generally 20 percent of the lesser of qualified income or taxable income but may be subject to limits based on wages and qualified property of the qualified trade or business. It’s important to note that one of the limits is taxable income rather than adjusted gross income. Consequently the tax benefit from itemized deductions such as charitable contributions and home mortgage interest may be lessened in cases where the Section 199A deduction is limited to 20 percent of taxable income. Furthermore, most state income tax returns start with federal adjusted gross income. Thus, taxpayers will not benefit from this new deduction at the state level unless similar legislation is enacted by the applicable state(s).

Tax rate changes

The Section 199A deduction is intended to compensate businesses operating in an entity type other than a C corporation for the tax rate cut C corporations received. The number of individual income tax brackets is still seven but the rate for all brackets, other than the 10 percent bracket, has been reduced. The top individual tax bracket is down 2.6 percent to 37 percent and is applicable to taxable incomes in excess of $599,999 for married filing joint taxpayers. Prior to TCJA the top comparable tax bracket applied to incomes in excess of about $470,000. Compare this rate cut to C corporations who now have a 21 percent flat tax rate down from a top rate of 35 percent prior to years beginning in 2018. Don’t be deceived by this 14 percent rate drop as C corporations are still subject to double taxation. With the pass-through deduction, most business owners will save more lifetime tax dollars by operating in partnership or S corporation form.

Next steps

It’s very important to consult your tax advisors as each taxpayer’s situation is unique. Some of the details and complexities were omitted above, and there may be other provisions of the TCJA not covered here that impact your business.

For more information and questions, contact Shawn Sullivan using the information below.

Shawn Sullivan

Executive Vice President
Tax Services

Shawn leads the firm’s tax group and serves on AGH’s board of directors. In addition to enhancing business performance to minimize tax consequences, he has extensive experience in mergers and acquisitions, international tax and business structuring. Shawn has public and private experience in the fields of tax and accounting and works frequently with clients in the manufacturing, automotive, wholesale distribution, real estate development and construction industries.

A certified public accountant, Shawn is a member of the American Institute of Certified Public Accountants, the Kansas Society of Certified Public Accountants (KSCPA) and chairs the KSCPA Committee on Taxation.

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