Manufacturing has long been a pillar of American commerce and economic growth, and to empower our economy and create jobs, Congress has developed numerous tax incentives for the industry you ought to know about to advise your clients. In addition, it’s critical to be aware of common compliance difficulties your clients’ businesses may face. Manufacturers need to be well informed about the opportunities they may be missing and the pitfalls that can expose them to significant risk.
Taking Advantage of Opportunities
Research & Development Tax Credit. Most manufacturers are engaged in some degree of product development. If these development activities include new products, significant improvements to existing product lines or manufacturing processes, such as increased durability, better features and enhanced efficiency, your clients may be eligible for the Credit for Increasing Research Activities. American taxpayers claim anywhere from $5 to $7 billion in R&D credits annually, but many taxpayers are engaged in activities that qualify for the R&D credit without knowing it. A common misconception is that a taxpayer must be pushing the bounds of known science to merit a tax credit. In reality, if taxpayers are employing “applied science” to resolve technical uncertainties about new or improved products or processes, they may be eligible for a big tax break.
Interest Charge-Domestic International Sales Corporation (IC DISC). Another relatively unknown strategy for manufacturers who have significant export sales is the Interest Charge-Domestic International Sales Corporation. This is a provision introduced by Congress to give domestic manufacturers an advantage in the international markets. It provides a mechanism for converting “ordinary” income, taxed at the highest marginal income tax rates (currently 39.6 percent), to “qualified” dividend income taxed at capital gains rates, and also provides a potential deferral of income. The savings potential here is huge – many taxpayers slash their tax bill on international profits by almost half, utilizing this strategy.
Domestic Production Activities Deduction. Manufacturers are also eligible for the Domestic Production Activities Deduction that equates to a deduction of 9 percent of manufacturing profits. In 99 percent of cases, your clients can’t get a tax deduction without spending money, but this is one instance where you can. In highly profitable years, this deduction yields a significant tax savings without having to spend another dime on operations.
de minimis safe harbor. Another consideration is a provision in the recently enacted “tangible property regulations,” known as the de minimis safe harbor. This was an effort by the IRS to relieve the administrative burden on taxpayers to track relatively insignificant asset purchases on their depreciation schedules. For taxpayers who are required to have their financial statements audited, or those who must file their financials with the SEC or any other government agency, the IRS will not dispute the immediate deduction of asset purchases of $5,000 or less, assuming the expenditure is also an expense on the financial statements. For all other taxpayers, this threshold is $2,500.
Be Aware of Potential Pitfalls
Uniform Capitalization Rules. On the compliance side, manufacturers are subject to the onerous Uniform Capitalization Rules that require additional absorption of general and administrative costs into inventory. In other words, a certain percentage of otherwise deductible overhead costs needs to be included in inventory (as an asset), and deducted when that inventory is sold.
Sales/Income Tax Nexus. Another big area of exposure is in state and local taxation. Manufacturers who sell and deliver products into other states can trigger unexpected tax liabilities. This includes employee travel, keeping inventory on consignment with an out-of-state dealer, hiring employees or storing property in other states, and creating what is known as nexus, or a connection, with other states that gives those states the right to tax sales and net profits.
Offshore Reporting. Finally, manufacturers commonly have international connections, whether they are foreign owners, ownership of foreign companies or contracts with affiliated companies abroad. Being oblivious to numerous and complex reporting requirements related to these relationships can prove quite costly. The IRS has a litany of forms to report various relationships with foreign individuals and businesses, as well as foreign asset holdings. Each one of these forms carries a hefty penalty for failing to file, late filing or incomplete filing. In addition, prices charged by one affiliated company to another across borders come under great scrutiny and can result in very adverse consequences, if great care is not taken.
These scenarios are just the tip of the iceberg when it comes to tax compliance, but they are areas of significant opportunity and risk. We know that retaining a qualified tax professional is critically important to the health and longevity of any business, not only to keep the manufacturer out of hot water, but also to enable the business to claim all the benefits and incentives to which it is entitled.
Editor’s note: We want to know what other industries or professions you want us to feature on the Intuit® ProConnect™ Tax Pro Center. Leave us a comment below to let us know, and see “Tax Tips for Real-Estate Professionals Who Are Self-Employed” for an article on tax tips for your real-estate clients.