Batten the Hatches
In times of uncertainty in the manufacturing industry, it’s natural to huddle up and think through strategies that protect the short-term while preparing for the long game. Companies will often turn to their advisors between waves of growth to review their operations and make sure they are taking every precaution and advantage.
There is always plenty to talk about in manufacturing. As stated in a previous article, the disruption of oil and gas and energy consumption has impacted companies in the region in direct revenue, but also in their relationships with related industries that rely on the oil and gas industry.
Some of the strategies we’ve seen manufacturers employ have included adjustments to work shifts and right-sizing. However, they are also looking at ways to reduce inventory, improve processes, look for tax breaks and even step up estate planning and succession. The following are areas of the manufacturing business that owners and management can review for savings and efficiency.
Smaller manufacturers don’t always perceive a qualification for the politically popular R&D credit. They should take another look. Some companies have discovered areas defined as R&D under the tax law that fit them perfectly even if they don’t consider themselves innovative. For example, an improved or proprietary process can qualify even if you don’t have an on-site lab or clean room. Also, think about that customer who asked you to make a small adjustment to the machining of a part. If you engineered it, it may qualify as R&D.
When companies are busy, owners or management aren’t always aware of qualifying innovation happening on the production floor. Consult with your CPA to bring those opportunities to light so they are communicated to staff and recorded regularly.
Other tax reduction strategies can be found in how manufacturers handle personal property taxes. Old assets should be removed from the books when new assets are purchased. Some assets may be improperly classified, resulting in overpayment. Many types of “equipment” can be exempt. In addition, certain idle equipment due to lack of demand may also be factored to reduce the personal property tax.
Of course, bonus depreciation is another go-to tax provision. Manufacturers may qualify under fixed asset expensing or through the Domestic Production Activities Deduction (DPAD). This allows for an additional 9 percent deduction of the lesser of taxable income, or 9 percent of “qualified production activities income” (QPAI). QPAI is equal to the amount by which gross receipts from eligible manufacturing and production activities exceed related expenses.
Activities include, but are not limited to:
- Manufacturing, production, growth or extraction of tangible personal property in the U.S.
- Construction of real property in the U.S.
- Performance of engineering or architectural services in the U.S. in connection with real property construction projects in the U.S.
A manufacturer may also qualify for additional tax rate reduction benefits under the interest-charge domestic international sales corporation (IC-DISC). This tax rate reduction is generated by creating a separate entity organized as a C-Corporation. The C-Corp is deemed to participate in the exporting process of the operating entity and earns a “commission.” That commission is paid by the operating entity, and it is an ordinary deduction, reducing ordinary income. Qualification for this type of tax reduction requires exploration of a manufacturer’s operation and sales chain as well as planning to set up the entity.
There are many other areas that manufacturers can explore with their CPA to improve their tax position.
Process Improvements for Manufacturing Operations
Manufacturers can look at various ways to improve efficiencies and reduce waste in the production line as well as save on utilities, maintenance and materials. In addition to integrated components and sensors to alert staff to potential breakdown, the design of production floors can improve workflow and move product out the door faster.
Manufacturers are also looking at simplifying the steps in each manufacturing process to speed production and make training and improvements easier later. Again, some of these may qualify for R&D, depending on the complexity of the changes and their impact on a particular product or the industry itself.
A lean process study and revamping of core processes could provide a double benefit of both improved profitability and production qualifications for the R&D credit.
Labor and Benefits
Texas-based manufacturers may experience more frequent inquiries by state and federal authorities regarding citizenship and fair labor practices.
Immigration and Customer Enforcement (ICE) will look at companies with a large workforce and ask for I-9s or proof of U.S. citizenship. If they find violations, they will give the owners a time period to comply or face fines. These inquiries and fines cause a disruption in business and unexpected costs. Manufacturers need to take a careful look at their employment rolls to avoid this turbulence.
The same can be said for trends in class action suits that target large groups of employees to pursue claims for unpaid overtime or unfair labor practices as outlined in the Fair Labor Standards Act. Employers, for example, that incentivize employees with bonuses based on production must also demonstrate compliance with any overtime owed to meet those production goals.
Manufacturers can receive incentives for hiring veterans or other special worker classes, but they must be careful when hiring these workers if reductions in force are required later. They don’t want to be perceived as manipulating the system, keeping employees only until requirements are satisfied.
On the benefits side, some larger manufacturers are setting up captive entities to self-insure the operation and/or employees — essentially paying premiums to their captive entity rather than to a third-party payer. If income is steady at $5 million to $6 million a year, a captive can provide another tool for owners as they plan for succession and retirement.
If you have any questions about how to add operational efficiencies, reduce taxes or plan for transfer of ownership in your manufacturing operation this year, talk to the manufacturing team at Cornwell Jackson.
Gary Jackson, CPA, is the lead tax partner in the Cornwell Jackson’s business succession practice. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services to management teams and business leaders across North Texas.