By: Travis Klein
There is a wide belief in economic studies, that the impact of the Tax Cuts and Jobs Act (TCJA) will spur economic growth and capital investment and consumer spending – and manufacturers are hopeful to see a heavy windfall from the economic gain. According to an Ernst & Young analysis of the revenue effects for businesses and key industries under the TCJA, the manufacturing industry is set to have the second highest impact on GDP over the next ten years with a growth percentage of 3.8% of the next five years.
It is vital for manufacturing companies to properly plan for TCJA. More than ever, internal and external finance and accounting teams should be relying on income tax and cash flow modeling to see how the new rules set forth will affect the company. Manufacturers, in particular, will largely see an impact from two major legislative items enacted in the TCJA which have to do with the depreciation of capital assets and the deductibility of business interest payments.
Manufacturing businesses have long benefitted from being able to accelerate depreciation expenses on tangible personal property, machinery and equipment, furniture and fixtures, and select real property up to certain thresholds for Section 179 and Section 168(k) bonus depreciation. Companies were also able to deduct interest payments with no or limited barriers. These concepts are largely tied together given that major capital investment often requires debt financing, which results in interest payments.
In comes the TCJA, which now limits net interest expenses to 30% of a taxpayer’s adjusted taxable income under Section 163(j), for taxpayer’s with three-year average gross receipts over $25 million starting January 1, 2018. An important, but possibly overlooked item within those rules, is that the $25 million test is for all entities under common control; such as companies that lease real estate to their manufacturing company. Adjusted taxable income is defined within as net income, while adding back depreciation, amortization, interest income, and non-trade business income/losses until December 31, 2021. Any interest expenses not allowed in a given year are carried forward indefinitely and treated as paid in the subsequent year, subject to the same annual limitations. For large manufacturers, the interest expense deduction is pertinent to limit their tax liability in any given year, while taking on debt at low-interest rates in recent years to pay for expansion, investments, and inventory to meet demand. It will be important to take these limitations into consideration for cash flow and income tax planning annually if the entity is heavily leveraged and part of the due diligence process in considering the pros and cons of taking on additional debt. Entities will likely re-consider an appropriate capital investment strategy given the tax law changes.
Although the interest limitations in the new legislation can put a strain on manufacturers, the new accelerated depreciation rules should be seen as a legislative win for the industry. Bonus depreciation under Section 168(k) has increased from being able to immediately expense 50% of the new property to immediately being able to write off 100% of the new or used property until December 31, 2022, if purchased and placed in service after September 28, 2017. Section 179 limits have also increased, allowing manufacturers to claim immediate expenses of up to $1 million of property per year while being fully phased out at $3.5 million of additions, tied to inflation after 2018. These provisions should immediately spur capital investment plans, thus driving up demand for manufactured products. Manufacturers should consider the impact the tax law will have on future supply versus demand in their particular industry sector while setting appropriate pricing models to maintain or increase profit margins. The increase in these cashless deductions will also allow manufacturers to invest heavily in increasing their outputs and efficiencies throughout their supply chain while investing in automation or hiring new employees.
Manufacturing companies need to have a plan in place as we head through 2018 to think about their business and tax planning strategies, how to finance investment and growth, global supply chain inputs, and pricing and profit margin benchmarks. The TCJA is complex legislation to navigate, and there is no better time to make sure your company is properly aligned with a qualified CPA firm to help with the detailed analysis’ and tax-planning needed to properly succeed under the new law. Today’s decisions will have long-term, and potentially costly or profitable, ramifications.
Travis Klein, CPA, MBA is a manager in the tax department and well-respected advisor for many of the firm’s commercial and residential real estate and manufacturing clients. Travis has a strong grasp of complex tax planning, consulting, and compliance matters facing business owners across various industries. He can be reached at email@example.com.