The Tax Cuts and Jobs Act (TCJA), enacted just a few days before the close of 2017, is the most significant piece of tax legislation in more than 30 years and affects nearly all manufacturers — no matter your size, specialty, market, or structure.
As you complete planning for the 2017 tax year, it's also important to turn to 2018 and beyond to address longer-range issues. How can you best prepare your manufacturing business for tax reform?
The six key impacts of tax reform on manufacturers
- Entity choice
Since corporate tax rates will decrease substantially while pass-through business tax rates will decrease by a lesser amount, C corporations will look more attractive than before. However, many other considerations that go in to entity choice decisions won't change, and in many cases, a pass-through structure may still be more advantageous. Making a proper determination of the ideal entity structure requires a holistic view — not only of the tax on operating income and distributions but also of the long-term outlook for the business and what any exit or transition plan may look like.
The bottom line:
Since many factors influence entity choice, manufacturers should carefully consider the pros and cons of making a change, including short- and long-term tax ramifications in addition to non-tax considerations. If you've made a decision, and you're ready to move forward, you generally must act by March 15, 2018. Otherwise, take the time you need to evaluate the impacts before rushing into a decision. - Eligibility for qualified business income deduction for pass-through businesses
Under tax reform, individuals and trusts may deduct up to 20 percent of qualified business income. This deduction has many exceptions and limitations, including some based on the type of business, W-2 wages paid by the business, and the cost of depreciable assets held.
It's critical for manufacturers to understand how these limitations may impact the deduction, because planning opportunities may be available to maximize it. For example, taxpayers may be able to increase W-2 wages or assets where they are not sufficient to support a full deduction, or they may be able to change the nature or structure of a business in order for more income to qualify.
The bottom line:
Overall, manufacturers need to project how this new deduction will impact them based on their current state to determine what steps will be necessary to maximize it. You might be able to take some of these steps toward the year end, but others may require more immediate action in order to take full advantage. - Business interest expense
Beginning in 2018, the deduction for business interest expense will be limited to the sum of business interest income plus 30 percent of the adjusted taxable income. Adjusted taxable income is defined as a tax-basis EBIDA for the 2018 through 2021 tax years and tax-basis EBI beginning in 2022.
The limitation will apply both to C corporations and pass-through entities, but small businesses with less than $25 million in average annual gross receipts for the prior three years are exempted.
A number of strategies exist for taxpayers who may be subject to the limitation. For example, interest could be minimized by restructuring debt into different types of preferred equity. For taxpayers with related-party debt, planning is especially important if the interest expense will be limited while interest income remains fully taxable.
The bottom line:
Planning related to the business interest limitation can take substantial time since it often involves parties not controlled by the taxpayer. The quicker taxpayers act, the more likely it is they will see savings. - Transactions, mergers and acquisitions (M&A)
Several provisions of tax reform will impact current and future transactions and M&A activity. Particularly, if you have a transaction in process or planned for 2018, manufacturers will want to carefully consider the impacts of the tax reform and any available strategies to minimize costs and maximize benefits.
Buyers might consider how to finance the acquisition in light of the interest expense limitations, whether a different entity choice is warranted, and whether an acquisition of assets may allow for immediate expensing of some depreciable assets.
Sellers might consider whether their approach to an asset or equity sale still makes sense in light of rate changes, how the sale will impact their eligibility for the qualified business income deduction, and what the value of transaction cost deductions and other tax attributes may be to them or the buyer.
The bottom line:
Many widely accepted tax concepts related to M&A transactions may look different as a result of tax reform, so manufacturers should closely review all aspects of transactions.C corporations will look more attractive than before. - Meals and entertainment
Tax reform bars the deduction of all business-related entertainment expenses, which were previously 50 percent deductible. Certain meals and employee fringe benefits will also be nondeductible.
The bottom line:
Taxpayers should evaluate the magnitude of expenses in this category and determine whether providing the entertainment or benefits still makes sense. At a minimum, take a look at your current accounting tracking mechanisms to determine if alternative methods would permit the business to more easily comply. - International issues
The tax law made significant changes to how foreign activity is taxed. These include a shift to a territorial tax system, a minimum tax on certain corporations with payments to foreign-related parties, a minimum tax on income earned in foreign subsidiaries, and a deduction for foreign intangible income and exported property.
These provisions are complex and often apply very differently to C corporations vs. pass-through entities, with pass-through entities generally treated less favorably. The changes could dramatically affect the manner in which a manufacturer is structured or the way in which its domestic and foreign operations interact.
The bottom line:
All manufacturers with foreign operations must understand how tax reform will impact them, including taking a hard look at existing structures and operations to determine if changes are needed to avoid adverse consequences. This is particularly true for manufacturers structured as pass-through entities.
Many of these actions have business and financial implications beyond tax alone.
Change is here
Many of these actions have business and financial implications beyond tax alone. That's why it's so important to understand and assess all the factors relevant to your particular circumstances before making significant changes.
As always, if you have any questions, feel free to give us a call.
