Inflation has slowed, but manufacturing companies are still contending with global supply chain issues, workforce shortages and questions about how pending legislation and the 2024 election will shape the corporate tax environment. All that uncertainty is continuing to make tax planning for manufacturers complicated. However, there are also opportunities for manufacturers to capitalize on favorable tax treatment.
Because tax planning is a highly unique process for manufacturers, tax advisors are key in identifying specific strategies that are viable in the current tax environment, as well as in specific jurisdictions. Manufacturing leaders will require specific guidance around maximizing deductions and minimizing tax liabilities, as well as long-term tax and M&A planning. Among many tax planning issues, here are eight that manufacturers are likely to encounter this year.
1. Research & Development Capitalization and Uncertainty
In disappointing news for manufacturers, the recent change to Section 174 of the tax code is once again going to impact how these entities are taxed on research and development costs. As a reminder, the 2017 Tax Cuts and Jobs Act included a provision that went into effect in 2022, eliminating the option for a company to deduct its qualified R&D expenses in the year they were incurred. Under the current rules, manufacturers must capitalize and amortize R&D expenses over five years or over 15 years for expenses incurred outside the U.S.
As we recently explained, the tax impact of the Section 174 change is potentially devastating for businesses that invest heavily in innovation. Manufacturers will be limited to a tax deduction of no more than 20 percent on their R&D expenses in 2023, affecting long-term spending decisions and overall tax strategy for these businesses.
However, there is pending legislation that would retroactively reverse the new provision and restore the option to fully deduct R&D expenses in the year they are incurred. The Build It in America Act would push the start date for the new capitalization and amortization rules to 2026. The House Committee on Ways and Means just passed it in June, so it is too soon to say whether this legislation will succeed or how it might be amended.
Finally, note that the R&D capitalization rules are distinct from R&D tax credits. Eligible businesses may still apply up to $250,000 in qualified R&D costs to their payroll tax liability each tax year. R&D tax credits are also still available at the state level in 35 states, including Maine. Considering the tax hit some manufacturers will take by amortizing R&D costs, maximizing all available R&D credits will be an important part of 2023 tax strategy for manufacturers.
2. New Tax Credits for Manufacturers Working in Clean Energy
Manufacturers working on projects related to clean energy may be able to take advantage of new tax credit opportunities created by the 2022 Inflation Reduction Act. The Advanced Energy Project Investment Tax Credit (48C) allows eligible taxpayers to claim a credit of up to 30% on certain clean energy investments, including costs incurred by renovating industrial facilities to reduce greenhouse gas emissions.
Manufacturers that have yet to apply for the credit before the July 31, 2023 deadline will not be eligible for 48C but may still be eligible for the Advanced Manufacturing Production Tax Credit (45X). This credit is available to entities that produce components for batteries and solar panels, among other clean energy parts. Manufacturers will be able to claim 45X credits based on the number of eligible units they produce each year. With phase-out not scheduled to begin until 2030, this credit may incentivize certain manufacturers to shift production goals toward clean energy components over the next few years.
3. Time Is Almost Up For the Employee Retention Credit
Many manufacturers qualified for the Employee Retention Credit (ERC) during 2020 and 2021 by keeping employees on the payroll through the worst of the pandemic. Any business that qualified for the ERC but never claimed the credit to offset payroll taxes may do so now by filing an amended payroll tax return. If there’s any chance that your business is eligible for an unclaimed ERC, speak to your tax advisors soon. The deadline for claiming a credit for 2020 wages is Tax Day 2024.
4. Bonus Depreciation and Section 179 Limitations Have Changed
Updated federal tax provisions will limit certain equipment-related deductions for manufacturers in 2023. Since 2017, changes created by the TCJA have allowed companies to claim 100% depreciation for capital equipment in the year the equipment was put into service. That allowance is being phased out starting this year, with bonus depreciation limited to 80% for 2023, 60% for 2024 and so on. (Maine’s decoupling from federal tax rules around bonus depreciation complicates these calculations, so Maine manufacturers are urged to consult their tax advisors with any questions about bonus depreciation.)
Relatedly, the Section 179 deduction limit has changed for 2023. Section 179 allows businesses to write off qualified equipment, vehicles and software in the year they’re purchased. The maximum Section 179 deduction for 2023 is $1,160,000 before any income and investment limitations.
5. Business Meal Deductions Return to 50%
The IRS raised the deduction for business meals to 100% for 2021 and 2022 as a temporary measure to boost restaurant sales during the pandemic. As of 2023, businesses are once again limited to a 50% deduction for the cost of business-related food and drink.
6. Section 163(j) Limitations Continue
A taxpayer’s business interest expense limitation generally is based on 30% of its Adjusted Taxable Income (ATI). For tax years beginning before January 1, 2022, ATI approximated earnings before interest, income tax, depreciation and amortization—EBITDA. However, for tax years beginning after December 31, 2021, it changed to an approximation of earnings before only interest and income tax—EBIT. (Note that ATI is computed under federal income tax rules, while EBITDA and EBIT are not.)
Said another way, computing ATI involving the “add-back” of depreciation, depletion and amortization does not apply for tax years beginning after December 2021. Applying the EBIT-like ATI computation results in lower ATI, a lower limitation, and lesser allowed tax deductions for interest expense for many businesses.
7. Estate Planning Remains a Perennial Tax Consideration
Estate planning is and will continue to be a top tax priority for business owners including manufacturers in 2023 and beyond. There have been routine updates to estate planning-related tax provisions this year, like the federal gift and estate tax exemption and Maine’s state estate tax exemption being raised to reflect inflation. But it’s the looming changes expected in 2026, when the TCJA is scheduled to sunset and the estate tax exemption is slashed in half, that taxpayers need to start planning around now.
8. Maine Could Be the Next State to Enact a Pass-Through Entity Tax
Maine tax professionals have been closely monitoring the evolution of pass-through entity (PTE) taxes in other states in recent years, and change might be coming here soon. Many states have introduced PTE tax strategies that allow owners and shareholders in S corps, partnerships and LLCs to circumvent the $10,000 cap on state and local tax deductions that was created by the TCJA.
Maine is now in the minority, having no PTE tax on the books, but that could end in 2023. Currently, a bill called “An Act To Support Maine Businesses Through A Child Care Tax Credit And A Pass-Through Entity Tax” is with the Maine Committee on Taxation. Its passage would create new opportunities for manufacturing business owners/shareholders to claim PTE credits against their Maine income taxes. Nothing is certain yet, but we will keep clients informed of any developments related to a Maine pass-through entity tax.
Contact ARB for Help With 2023 Tax Planning for Manufacturers
ARB’s Manufacturing Advisory Services team has a deep understanding of your unique tax needs, which allows us to help navigate federal and state tax codes with ease. Our team is eager to help you stay on top of tax law changes and answer whatever questions you may have about tax planning for this year or for the future. Contact us today.
by John E. Hadwen, CPA
John Hadwen joined ARB in 2021 as a tax director. He specializes in providing individuals and businesses with comprehensive tax compliance and consulting services related to closely-held business, manufacturing, construction & real estate, and professional services firm taxation. Prior to joining ARB, John was a Tax Principal at a large, regional CPA firm.