There’s no question that manufacturing businesses are capital-intensive. From investing in heavy machinery to maintaining a skilled workforce, manufacturers incur a wide variety of costs in the course of business.
Fortunately, many tax opportunities exist that offer manufacturers the opportunity to offset some of these expenses, from the costs incurred in developing new products to the business’s international tax obligations.
In recent years, these tax opportunities have continued to evolve and change as new legislation passes. There is now a wide range of tax credits and incentives that manufacturers can pursue to create a more efficient tax strategy. These exist on both a federal and a state level. We explore some key opportunities available below.
The ten most impactful opportunities available to manufacturing businesses include:
Let’s explore each of these benefits in a little more detail.
R&D tax credits allow businesses to apply qualifying R&D expenses as a dollar-for-dollar reduction against federal income taxes. Typically, a manufacturing business can use these credits to offset between 6 – 8% of qualifying R&D expenses.
These expenses, which include wages, supplies, and contract research expenses, must pass a four-part test to be considered qualifying expenses for this tax credit:
There are many intricacies involved in R&D tax credits and it’s a highly specialized field so businesses should consider engaging the support of an experienced tax advisor to claim the credit. Additionally, 2022 saw significant changes to R&D laws. While these do not affect the credits themselves, they do have a major impact on the manner in which businesses account for R&D expenses.
The 2017 Tax Cuts and Jobs Act created a provision that broadened the ability for businesses to immediately depreciate machinery, equipment, computers, leasehold improvements and other business assets with recovery years of 20 periods or less.
To do so, businesses can elect to use either bonus depreciation or the Section 179 deduction.
Bonus depreciation rules currently allow businesses to depreciate 80% of qualifying expenses for assets placed in service in 2023. This benefit is scheduled to gradually phase out, dropping to 60% in 2024, 40% in 2025, and 20% in 2026 before being eliminated in 2027.
Depending on the states a business operates in, the Section 179 election, which allows businesses to deduct the cost of qualified property, may be a better fit. Some states require the add back federal bonus depreciation for state tax calculations, but not for Section 179. The maximum allowable deduction under Section 179 is $1,160,000 for the 2023 tax year.
For manufacturing businesses that export their products internationally, the FDII deduction represents a major opportunity to minimize tax on this income.
The FDII deduction enables businesses to reduce their effective federal income tax rate on intangible income from foreign sales to 13.125%, a major saving when compared to the standard 21% corporate tax rate. This lowered rate applies until 2026 when it is scheduled to be increased to 16.406%.
The WOTC is a federal tax credit that rewards businesses that hire employees from targeted groups who have traditionally faced significant barriers to employment. These groups include veterans, formerly incarcerated individuals, and individuals experiencing long-term employment.
In general, the WOTC allows businesses to claim a credit of 40% on up to $6,000 of wages paid to an individual in a targeted group starting in their first year of employment. But the benefit can be as high as $9,600 depending on how an employee qualifies and the amount of their wages.
The ERC was a COVID-era stimulus that aimed to support businesses to keep employees employed throughout the pandemic. It offered a credit on qualified wages paid to employees between March 13, 2020, and September 31, 2021, provided certain criteria were met.
It’s not too late for businesses to amend their tax returns to retroactively take advantage of this credit: businesses have until 2023, or in some cases, 2024, to amend their tax filings.
Similar to the FDII deduction, the IC-DISC offers attractive federal income tax saving opportunities to manufacturing businesses that export their products internationally.
An IC-DISC is a separate legal entity that acts as a selling agent for the manufacturing business. This new entity earns a commission on either 50% of the net income from qualifying export sales, or 4% of gross receipts from qualifying export sales: whichever is higher. The IC-DISC pays no federal income tax and its profits are distributed to its owners as dividends taxed at more favorable capital gains rates.
Depending on the jurisdiction your business operates in, there are a wide variety of sales tax exemptions that may apply. In many states, sales tax exemptions apply for the purchase of manufacturing equipment such as machinery used in operations, as well as safety equipment.
Not every purchase a manufacturer makes is exempt from sales tax. Each state has its own standards that dictate what purchases qualify for sales tax exemptions and what filings are required. Manufacturers should consult with their tax advisors to avoid any mistakes that may lead to underpayments.
Interested in learning more about sales tax exemptions? Contact Smith + Howard’s Multistate Tax Services team.
The QBI deduction, also known as the Section 199A deduction, is another tax opportunity that was included in the 2017 Tax Cuts and Jobs Act. It can be extremely advantageous for individual owners of manufacturing businesses.
This deduction is taken at the individual level and allows a deduction of up to 20% of the income earned through a qualified trade, although limits do apply and it is set to expire in 2025.
Cost segregation studies enable manufacturers to break large assets (such as manufacturing plants) into a series of smaller assets (such as electrical systems and flooring) with shorter recovery lives.
This allows manufacturers to depreciate portions of their property over shorter periods, deferring taxes and improving cash flow. When used in tandem with bonus depreciation, cost segregation studies can be extremely impactful.
In addition to the federal tax opportunities listed above, there are many state tax credits available. These range from state R&D tax credits to job creation credits. Many states also have energy conservation credits and a variety of other incentives that reward businesses that operate in an environmentally sustainable manner.
Of course, state tax credits differ significantly from state to state. To understand the opportunities available to your business, consult with a tax advisory firm such as Smith + Howard that has significant experience partnering with manufacturing businesses operating on a national scale.
Determining which tax opportunities are appropriate for a manufacturing business to pursue is far from straightforward, particularly for well-established businesses with operations across multiple states and countries. Both businesses and tax laws are constantly evolving, so creating an optimal tax strategy demands real expertise.
At Smith + Howard, our tax team works closely with manufacturing businesses across the country. Our specialists partner closely with business leaders to build tax-efficient strategies that enable businesses to grow and prosper while minimizing their tax burden.
To learn more about tax opportunities for your manufacturing business, contact an advisor today.
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