The manufacturing industry makes up the backbone of the U.S. economy and, as such, there are many tax incentives aimed at helping manufacturers grow and thrive. Below, you’ll find 10 of these manufacturing tax incentives available to you in 2021:
Depreciation Expensing Under Section 179 and Bonus Depreciation
Manufacturers are allowed to expense up to $1.05 million in fixed asset additions under Section 179 if the total additions are less than $2.62 million each year. Section 179 expense is limited to taxable income and allows the taxpayer to select which assets to expense and how much. It’s important to note more states allow Section 179 than bonus depreciation.
Manufacturers can also claim bonus depreciation that allows immediate write off of all fixed asset additions, with no limits. This can be taken without taxable income limitation and can put the business in a taxable loss position, but it must be taken on all additions in the same asset class. Many states do not allow bonus depreciation.
Research and Development (R&D) Credit
Manufacturers are in an excellent position to claim this credit, which was created to provide a tax credit for the development or improvement of new or existing products or processes. The R&D process must be technological in nature, involve process of experimentation, and be subject to uncertainty.
The credit is based on R&D wages (direct, support, and supervision), materials, and subcontract costs. It is calculated in different ways using a 20% or 14% rate. And it can be claimed as an income tax credit (for all businesses) or as a payroll tax credit (only for those businesses with less than $5 million in sales and operating for five years or less).
Cash Method for Tax
Manufacturers under $26 million in gross receipts (using a prior three-year average) can elect to use the cash method for tax purposes. This method matches the tax to when the income is received and the expenses are paid. It requires capitalizing materials to inventory (labor and overhead related to inventory are expensed).
The cash method creates a big deduction when the business changes to the cash method, allows for additional deferral of income as the company grows, and makes year-end tax planning very flexible.
Last In First Out (LIFO) Inventory Method
For manufacturers with increasing inventory costs, the LIFO costing method provides for inventory to be valued using base year values, with new costs being expensed currently. This method creates larger deductions for the business as the inventory pricing increases.
To use the LIFO method, the company must also use LIFO for book purposes, which can also result in lower book income.
Entity Structure Planning
Based on a manufacturer’s current situation, and its long term and short term objectives, it may make sense to change the manufacturer’s type of entity for tax purposes.
- A partnership may want to change to an S corporation to increase its QBI deduction (see below) and save on self-employment tax.
- An S corporation may wish to revoke its S status to pay tax at the lower C corporation rates (currently 21%). They could also take advantage of FDII (see below) if the owners do not want/need distributions, the company needs to conserve cash, or to hold the C corporation stock five years to take advantage of the Qualified Small Business Stock exclusion (QSBS/Section 1202 stock).
- A C corporation may wish to make an S election so the owners can take more money out of the business and have one layer of tax if the company plans to sell in five or more years.
A change from an S or C Corporation to a partnership could be a taxable event.
Qualified Business Income (QBI) Deduction
This incentive is for manufacturers who operate as an S corporation, a partnership, or sole proprietorship. It allows a 20% deduction (through 2025) of the company’s taxable operating income— limited to 50% of wages or 25% of wages and 2.5% of qualified property.
For those owners at the highest tax rate of 37%, the manufacturing income is taxed at 29.6%.
Interest Expense Limitations
Manufacturers over $26 million in gross receipts (prior three-year average) have an interest expense limitation up to 30% of taxable income, plus interest, depreciation, and amortization expense. Starting in 2022, the interest expense will be limited to 30% of taxable income, plus interest expense only. Manufacturers should carefully plan for this limitation by evaluating their debt and equity situation.
Foreign Derived Intangible Income Deduction (FDII)
This incentive is for manufacturers who export goods. It has the effect of cutting the tax rate on foreign source income to as low as 13.125% for C corporations through 2025.
It is not available for S corporations, partnerships, or sole proprietorships.
Employee Retention Credit (ERC)
The ERC for 2021 is for manufacturers who had a decline in sales by more than 20% by quarter for 2021 over 2019. This credit is refundable and is based on 70% of an employee’s wages, plus health insurance. This is limited to $10,000/employee for each quarter the business qualifies (maximum credit is $7,000/employee/quarter).
The business gets the credit each quarter it qualifies plus the following quarter (even if it doesn’t qualify). These wages cannot be also used for PPP loan forgiveness.
Legislation was recently signed to end this credit for wages paid after September 30, 2021.
WA Sales and Use Tax Exemption
Manufacturers in Washington state are exempt from sales and use tax on machinery and equipment used directly in manufacturing or research and development. Also included is the labor and services to install, repair, alter, or improve the qualifying machinery and equipment. This exemption is similar those provided by many other states.
Manufacturers should consider their situation and see how these tax incentives can help their business and its owners through these challenging times. Please consult with your Clark Nuber professional or contact Rene Schaefer with any questions.
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