February 27, 2017
Tax Planning for Manufacturers and Distributors
Here we are in the midst of another tax return filing season. You are a business owner and are planning to gather information for the entity's tax return. With this in mind for the 2017 filing season and beyond, it is important to remember that tax planning is not confined to year-end. There is no bad time to strategize and find new opportunities to create potential tax savings. There are several strategies manufacturers and distribution companies can consider to recognize such benefits. Some of the topics mentioned below can be utilized to offset the 2016 year-end liability, and others can be used for future planning.
Companies that purchase, renovate or construct real property may have the opportunity to accelerate depreciation deductions. Non-residential property is depreciated over a 39-year period and residential property over 27.5 years. Using a process known as "cost segregation," a company can separate a building's components, such as walls, floors, and ceilings. When a building's components are separated, the company can depreciate property at a shorter depreciation period using a practice called component depreciation. The depreciation at shorter periods of time will accelerate deductions into earlier years.
Companies should consider taking advantage of accelerated depreciation such as Section 179 and bonus depreciation deductions. Section 179 became a permanent fixture of the tax code when it was signed into law by President Obama within the PATH Act of 2015.
Bonus depreciation also provides for additional first-year depreciation for new property placed into service. The renewal of bonus depreciation deductions was extended to 2019.
Both Section 179 and bonus depreciation can be elected at the time the tax return is prepared, and no prior special planning is required.
Research and Development Credit
Companies that incur research and development costs may be eligible for the R&D credit. The credit was instituted to encourage research and experimentation in the U.S., related to the development of new or improved existing components. This credit also became permanent at the end of 2015 as part of the PATH Act. The R&D Credit, effective for year-end 2016, now includes more taxpayer-friendly provisions such as allowing the credit to offset the alternative minimum tax and, in the case of start-up companies, to offset payroll taxes rather than income taxes.
The availability and use of the R&D credit can be determined after year-end. However, the Internal Revenue Code requires substantiation of the costs allowed, in order to compute the credit. This analysis and report should be prepared along with the company's tax return and should be kept on hand in case of IRS inquiry.
Domestic Production Activities Deduction (DPAD)
Companies that manufacture or produce goods in the USA and have taxable income can take advantage of the Domestic Production Activities Deduction (Section 199 or DPAD.) Activities such as manufacturing, growing, extracting (as in minerals and other natural resources), and construction within the U.S. can qualify a company for the DPAD deduction, providing the company has U.S. W-2 wages.
DPAD can provide manufacturers with a tax deduction in excess of book costs. The deduction is based on 9% of qualified production activities. The computation of this deduction can be made at the time the tax returns are prepared.
Computing the DPAD deduction entails a complex set of rules that also provides for several alternative methods. Many accountants are not aware of this program or how to compute the deduction. U.S. manufacturers should ensure their tax return professionals are including the DPAD calculation when preparing returns. The deduction is computed on IRS Form 8903.
If you have any questions about these or other tax strategies that can help your business reduce its tax burden, contact your Marcum tax advisor.