Manufacturing
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Domestic manufacturing businesses carry with them tremendous tax planning opportunities that most small to medium-sized businesses aren't taking advantage.
On the accounting side, manufacturers must keep track of raw materials, work-in-process, and finished goods in order to properly calculate financial standing and performance.
Further, cash management is paramount in keeping the organization healthy.
In General
Manufacturing Deduction (pre-2018)
An important tax benefit for manufacturers is the domestic production activities deduction (DPAD), also known as the manufacturing deduction. The deduction is equal to nine percent of the lesser of the taxable income or qualified production activities income (QPAI). The deduction is available if a business has income from the rental, sale or other disposition of tangible personal property, buildings (but not land), computer software, and other products. The products must have been manufactured, produced, grown or extracted primarily in the United States. The deduction is also available for income from certain services, such as engineering and architecture. The deduction is reported on Form 8903, Domestic Production Activities Deduction.
(DPAD has been replaced with the more generous Qualified Business Income Deduction (QBID))
Depreciation
Depreciation - the write-off of the cost of an asset - is an essential element of tax accounting for a business. Property is depreciable if it is used for business, has a useful life exceeding one year, and may wear out or lose value from natural causes. Property that appreciates in value can still be depreciated if they are subject to wear and tear. Depending on how much income is generated by the business, the general goal in taking depreciation is to be able to write off property over the shortest period available, based on the property’s useful life. Most property is depreciated under MACRS, the Modified Accelerated Cost Recovery System. However, rather than claiming depreciation deductions, intangible property is amortized under Code Sec. 197. Taxpayers can also use cost segregation studies to reduce the period over which specified assets must be depreciated.
Research Credit
Research Credit Under the PATH Act of 2015
The Protecting Americans from Tax Hikes (PATH) Act of 2015 modifies and makes permanent the credit for increasing research activities (research credit). The PATH Act also adds the research credit to the list of general business credit components designated as “specified credits” that may offset alternative minimum tax as well as regular tax, effective for tax years beginning after December 31, 2015. In addition, a qualifying small business may make an election to apply a specified amount of its research credit for the tax year against the 6.2% payroll tax imposed on the wages that it pays to its employees.
Background
When it was first enacted in 1981, the research credit was to terminate after four and a half years. However, it has been extended several times over the years, and was allowed to expire at one point without a retroactive extension back to the prior termination date.
Domestic Production Deduction (Pre-2018)
Beginning years after December 31, 2017, the Domestic Production Activities Deduction has been suspended. However, most taxpayers who previously qualified for this deduction will now be able to take advantage of the new Qualified Business Income Deduction under Code Sec. 199A. More info to come soon.
Code Sec. 199: Benefits and Burdens
The Code Sec. 199 domestic production activities deduction (DPAD) can be particularly beneficial. The deduction equals nine percent of income from the manufacture or production of qualified property. Qualified property generally is tangible personal property.
The taxpayer must own the property while it is being produced. While ownership is not an issue in many cases, it is important for taxpayers that enter into a contract manufacturing arrangement. In a contract manufacturing arrangement, one party contracts with another, unrelated party to produce the property for which the deduction is claimed.
Ownership depends on who the benefits and burdens for the property, at the time that the property is manufactured or produced. Determining benefits and burdens depends on all the facts and circumstances. Recent developments have spotlighted the issue of benefits and burdens under Code Sec. 199. These include a Tax Court decision, ADVO, Inc., 141 TC No. 9 (2013), and an IRS Large Business & International Division directive, LB&I-04-1013-008 (2013).