By Gary G. Wallace, CPA | Tax Partner | Manufacturing Industry Team
U.S. Manufacturers face higher tax costs than almost all of our competitors in other countries.
The corporate tax rate in America is one of the highest among developed nations, and it puts the manufacturing industry at a significant competitive disadvantage in the global marketplace, according to the National Association of Manufacturers. For U.S. manufacturers, these statistics reveal that such taxpayers need to take advantage of any and all applicable tax breaks when they are available. It is concerning that many manufacturing businesses are not aware of some of the federal income tax breaks available to U.S. manufacturers through the Internal Revenue Code. For your reference, we have highlighted a few of these applicable tax breaks:
A manufacturer that is experiencing inflationary increases in its inventory pricing directly or according to governmental indices (Producer Price Index) should consider the adoption of LIFO inventory for income tax purposes. LIFO stands for last-in, first-out. Generally, the LIFO inventory method will result in a reduction of taxable income in an inflationary situation. Swings in transportation costs, weather related matters, customs and other factors may have a significant impact on inventory pricing. This provides an opportune time to revisit a change to LIFO when calculating your taxable income. The use of government indices has significantly simplified the required accounting for a LIFO taxpayer. To adopt LIFO inventory, a taxpayer need only make an election with the current year income tax return and make the required calculations. The IRS does require financial statement conformity, meaning that the company’s financial records, including external financial statements are also to be maintained on a LIFO method.
Domestic Production Activities Deduction
Manufacturers may benefit from a specified deduction of up to 9% of qualifying production income. This expense is a deduction when calculating taxable income and, unlike many other tax incentives, is not required to be recaptured in later years. Congress established this incentive in 2004, and it was initially a 3% deduction but is now 9%. The definition of “producers of qualifying property” that are eligible for the deduction may extend beyond traditional manufacturing and may include certain assembly or co-packer categories, depending upon whether the taxpayer has benefits and burdens of ownership. The IRS has recently issued additional guidance regarding the benefits and burdens considerations, so it may be an opportune time to readdress this deduction for your business. There are other limitations on the deduction, such as percentages of qualifying wages and taxable income limitations.
Research and Experimentation Tax Credits
Congress established the research credit program in 1981. The research credit is an incentive for businesses to be innovative and conduct research. Manufacturers should be aware as the definition of research and experimentation is much broader than one might think. Lab coats and test tubes are not required, and often the credit is valid for innovative thinking and testing of new processes. The requirements to qualify for the credit are generally based on U.S. based labor and materials. Many manufacturers are conducting such qualifying activities and may be eligible for the credit but have not performed the analysis necessary to report the credit. Congress recently extended the research credit through December 31, 2014, and taxpayers may also file amended returns for prior years to take the Federal credit.
Additionally, many states offer a research tax credit as well. For example, Virginia offers a refundable state credit for eligible expenditures. The credit may be up to $35,100 per year. The Virginia credit is refundable and so the taxpayer does not need to be in a taxable position to receive the Virginia credit. On January 6, 2015, the Virginia Department of Taxation published final updated guidelines for the Research and Development Expenses Tax Credit. These guidelines are now available on the Department’s website. See Research and Development Expenses Tax Credit Guidelines.
Interest Charge-Domestic International Sales Corporation (IC DISC)
The Interest Charge-Domestic International Sales Corporation (IC DISC) is a federal tax benefit for businesses that participate in exporting of their products. Companies that export products outside the U.S., including Canada and Mexico, can save more than 50 percent on their federal income taxes related to export sales.
The IC-DISC provides U.S. exporters and their shareholders with a tax savings of up to 20 percent of net export income. An IC-DISC structure is specified in the Internal Revenue Code and operates as follows:
A U.S. exporter or shareholder(s) forms an IC-DISC that is owned by the shareholders of the corporation. The U.S. exporter receives a tax deductible commission at regular tax rates. The qualifying IC-DISC entity pays no U.S. income tax on the commission income. The commission income is accumulated in the IC-DISC and remains untaxed until the IC-DISC pays a dividend to its individual shareholders at the lower preferred qualified dividend tax rates. For taxable years beginning in 2014, IC DISCs are also exempt from Virginia income tax.
While manufacturing businesses continue to seek opportunities to be competitive in today’s new economy, taking advantage of available tax breaks, is a must. The above points highlight several strategies but are general in nature. We recommend a thorough review of your tax situation to ensure you are planning appropriately. Should you have questions related to this topic, contact Gary Wallace, or your Keiter tax professional at 804.747.0000 | email
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.