As manufacturing companies begin to plan for 2020 year-end and future year tax reporting, they may be able to take advantage of opportunities that could provide valuable tax benefits. This relief is especially helpful in times of financial uncertainty such as the current slowdown caused by the coronavirus pandemic.
CARES Act – Treatment of Net Operating Losses
The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows companies that incurred net operating losses (NOLs) in 2018, 2019, or 2020 to carry back the losses to each of the five tax years preceding the tax year of such loss. The CARES Act temporarily removed the limitation that NOLs could be used to offset no more than 80% of taxable income.
This relief can create immediate cash flow for many manufacturers. While this provision can be very beneficial for many businesses, some taxpayers may experience unintended consequences. Businesses with controlled foreign corporations should carefully consider the interplay of NOL carrybacks with other Internal Revenue Code (IRC) provisions, especially the transition tax imposed under IRC Section 965. Companies also should consider the effect of carrying back NOLs on foreign tax credits, research and development (R&D) credits, and alternative minimum tax (AMT) liability.
CARES Act – Provisions for Depreciation
Another aspect of the CARES Act is a correction made to an error in the Tax Cuts and Jobs Act of 2017 (TCJA) regarding the life of qualified improvement property. Qualified improvement property is any improvement made by a taxpayer to an interior portion of commercial property (provided the improvement is not attributable to an enlargement of the building, elevators or escalators, or the internal structural framework of the building). Under the CARES Act, qualified improvement property is now classified as 15-year property eligible for bonus depreciation. The change applies retroactively to property placed in service in 2018 as well, which may provide taxpayers with opportunities to file amended returns.
Manufacturers can maximize depreciation deductions to lower 2020 taxes or increase NOLs for a potential refund or carryback opportunities. Companies considering buying new equipment or planning to remodel facilities should consider these benefits.
R&D Tax Credit
Many manufacturers incorrectly believe they cannot take advantage of the research and development (R&D) tax credit, which is one of the most significant incentives for businesses in the U.S. tax code. However, many manufacturers are developing new processes and workarounds in response to the coronavirus in order to keep their employees and customers safe and to comply with government regulations. Companies can qualify for an R&D tax credit if they design, develop, or improve products and processes for internal use, as well as for sale to customers. The federal R&D tax credit can help a broad range of manufacturers replenish cash spent on innovation and improvements to their processes.
The federal R&D tax credit is available for R&D expenditures incurred in the United States and it effectively allows a credit of up to 10% of eligible expenses. Because it is based on eligible expenditures, there is no maximum amount of credit that can be generated. The federal credit can be used to offset income tax or, if eligible, employer payroll taxes. Any unused credit can be carried back one year and forward up to 20 years. Some eligible companies also may be able to amend the prior three years of their returns to claim credits retroactively. In addition to the federal credit, more than 30 states also provide an R&D tax credit to reduce taxable income.
Additional Tax Relief Opportunities for Manufacturers
Manufacturers may be able to take advantage of several other tax planning opportunities and benefits:
- The IRS is allowing more business interest expense to be claimed. The adjusted taxable income percentage used to calculate the deduction limitation under IRC Section 163 was increased from 30% to 50%. Because the economic problems caused by the coronavirus are expected to produce lower taxable income in 2020 than in 2019, the IRS will allow taxpayers to use the 2019 adjusted taxable income to determine the limit in 2020.
- Excess business loss rules related to pass-through entity owners have been suspended.
- Business owners may be able to obtain refunds by carrying back losses from pass-through manufacturing businesses.
- The corporate charitable deduction limit was increased from 10% to 25% of taxable income for 2020. The individual limit was increased to 100% of taxable income.
The IRS code is complex and it is essential to consider the overall impact of applying various tax strategies to your company’s current tax profile and to model potential tax savings to determine how these strategies interplay with different sections of the code. Please contact us so we may provide guidance on these potential tax-saving opportunities to help you steer your manufacturing company through these uncertain economic times.