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by Justin Mentele, CPA

Are you leveraging the lowest tax rates and highest exemptions available under the current tax code? These opportunities really do exist, and they’re incredibly rewarding. 

Tax-planning season is underway, and the landmark Tax Cuts and Jobs Act of 2017 continues to create confusion among manufacturers. This overdue tax reform was hyped as monumental and significant, yet it went over like a lead balloon, in part because it includes complex—some might say unclear—regulations.

Even seasoned tax professionals shared in the uneven emotions following passage of this law. We first faced a lack of information to make completely informed decisions, then we felt overwhelmed by the charge to interpret the 500-plus pages of changes against the clock. Feedback from taxpayers was not positive, although ultimately, we discovered that, excluding a few circumstances, most manufacturers would be pleased with the monumental reform.    

Finding Joy in Tax Reform

If you felt overwhelmed with the original new tax code, you’re not alone. The good news is that there has since been illumination around key parts of the TCJA as a result of new rules and additional guidance provided by the IRS. What once was anxiety has turned to joy because it’s proven that with proactive planning, tax reform has opened more opportunities for companies to flourish and increase cash flows. 

Numbers don’t lie. After working with manufacturing clients, I have personally observed opportunities that have created between $200,000 to $1 million per company, depending on the structure and size of their operations.

Don’t assume that tax reform won’t benefit you or that it’s too complex to apply. If you’re not taking advantage of these tax changes, you’re likely losing money. It’s essential to ensure your business is taking every advantage of the lowest tax rates and highest exemptions available under the current tax code.

By being proactive now, you can capitalize on some of the most favorable tax and estate rates we have seen in more than 30 years. Consider these strategies.

Maximize Entity Structure

This first opportunity packs the largest tax advantages for manufacturers, but it’s also the most complex. To truly evaluate your company’s opportunities, contact a tax professional to provide an in-depth analysis and long-term tax strategy. With that disclaimer, let’s talk opportunities and options.

Through tax reform, we have had the pleasure of seeing reduced tax brackets for individual taxpayers. This especially helps owners of pass-through entities such as partnerships and S corporations. To further help pass-through owners, tax reform created a deduction called the Qualified Business Income (QBI) Deduction, more commonly referred to as the pass-through deduction.

This deduction allows for up to 20 percent of your income in your company. However, it must be noted that there are limitations to this deduction including wages paid, qualified business income, and taxable income. This is where proactive planning comes into play. As a company, you need to understand how each of these limitations can affect your owners and adjust to gain the most benefit later.

The other big change as it pertains to entity structures is that C Corporations now have a flat tax rate of 21 percent rather than a graduated rate, which was the case prior to 2018. The one thing I heard more than anything else as a result of tax reform was that every company should just be a C Corp. As a gut reaction from the rate alone, it would be hard to argue. However, C Corporations have the same limitations now that they did previously. It is still hard to get assets out of C Corporations without being double taxed—meaning that the corporation is taxed on the income when earned, then the owner is taxed again when the income is distributed.

This is where the discussion becomes complex. If your company is formed as a pass-through entity, you should enjoy the pass-through deduction as well as reduced tax rates. If you are formed as a C Corporation, you will enjoy an even lower tax rate.

Each has its benefits and disadvantages. Where the greatest opportunities lie for manufacturers is in the possibility of utilizing different entity structures to allow for maximization of decreased tax rates, possible staggering of year ends, and better cash management.

If you haven’t yet discussed your entity structures, you may be overlooking a potentially rewarding opportunity.

Consider Applying the Cash Method of Accounting and Inventory Capitalization

The cash method of accounting and inventory capitalization rules were excessively stringent for manufacturers before tax reform. Prior to 2018, the litmus test for either depended on whether your company had average gross receipts in excess of $1 million. That test has now increased to $25 million.

 With these benefits available to more companies than before, there is a need to evaluate them—especially at a time when cash flow is tight.

Here is a high-level look.

In perhaps overly simple terms, revenue is recognized for tax purposes when the cash is received, and expenses are recognized as they are paid. As is the case with most tax rules, there are technicalities and rules that complicate this. The opportunity in using the cash basis of accounting is in cash control. It gives a company the ability to pay tax on revenue as cash is received, as well as have better control of income through strategic buying and selling of needed items.

Largely known as 263A costs, the IRS calls for certain administrative expenses to be capitalized into inventory. This reduces deductible expenses in the year capitalized and increases taxable income. With the change to tax reform, if qualifications are met, businesses that were previously required to capitalize certain costs as part of inventory (Section 263A) also are exempted from this provision.

The uses of these two provisions sound relatively minimal as an opportunity at first glance. However, these provisions have allowed for enormous tax savings for our clients. There have been hundreds of thousands of tax dollars saved by individual companies utilizing these two provisions; putting money back in the taxpayer’s pocket. This is a welcome addition to cash flow during this sluggish economy.

Accelerate Depreciation to Control Tax Liabilities and Timing

The third opportunity is the one that I would think would never get missed, but it does. Tax reform has created unprecedented opportunities with the purchase of assets, primarily because companies are now able to expense fixed asset in the year those assets were purchased.  This can be done two ways: bonus depreciation, or the Section 179 expensing deduction.

Bonus depreciation is an accelerated depreciation method that allows for certain new and used property to be expensed at 100 percent of cost. The expensing percentage used to be 50. The expensing percentage remains 100 percent until 2023, when it reduces to 80 percent. It reduces an additional 20 percent each year until 2027. 

Section 179 allows a business to immediately expense the cost of qualifying property, rather than recovering costs through depreciation deductions. The expense allowance is now $1 million. There are certain phase-out thresholds with this expense.

Depreciation has increased the ability for companies to better control tax liabilities. Understanding that accelerating depreciation is a tax deferral, not a tax mitigation method, is an important piece of this opportunity. It allows for better knowledge of where a company is from a tax perspective and gives them the power to dictate the timing of tax liabilities and better use the tax brackets.

Looking back, tax reform was intended to simplify taxes for everyone. It failed on that front. By focusing on that message, we missed key underlying opportunities. What has surfaced, through careful consideration and proactive planning, are amazing opportunities that can positively impact your company through a comprehensive analysis of your entity structure, eligible basis of accounting methods, and use of depreciation.

Through the application of these tax strategies, there is not a question of if you will benefit but rather how much you will benefit.