The “Taxman” cometh in April; but it is wise to be prepared in December. The dreaded April 15th, when all those hard-earned dollars are due to Uncle Sam, is right around the corner. Manufacturing companies and their owners can and should take steps in December to minimize their tax burden in April. As we explore some of these year-end tax planning opportunities, it is important not to let the tax tail wag the dog; businesses should not spend a dollar to save 40 cents in taxes unless that dollar brings economic value to the company.
Before we delve deeper into tax planning opportunities, there are two underlying considerations:
- Coordinate business tax planning with individual tax planning: Most small to mid-market businesses are structured as pass-through entities (S-Corps/Partnerships /LLCs). Under these structures, the business does not pay income tax. The taxable income/loss of the business is reported on the owner’s individual tax return and the tax is paid at that level. As a result, it is critical to coordinate tax planning for a business with ownership tax planning.
- Assess whether your income brackets are likely to change: As a general rule of thumb, businesses should accelerate deductions and defer income when tax brackets remain consistent year to year, or if the current year is in a higher tax bracket. If 2016 was a strong year, it is likely that you will want to accelerate deductions into 2016 and defer income into 2017. Conversely, if 2016 was a down year, the company would take the opposite approach.
Now let’s examine some of the various tax planning opportunities:
- Timing of payments: Determine when to make related-party payments. Most related-party transactions (owner’s interest related-party rent, ownership bonuses, etc.) are treated on a cash basis. Companies should make these payments depending on if they want to accelerate or defer deductions.
- Have your fixed asset ledger up to date: Due to Section 179 deductions and Bonus Depreciation, fixed asset additions create a tremendous opportunity to manage taxable income for assets purchased and placed in service before year-end. Although these determinations do not need to be made until after year-end, a company needs to know what impact tax depreciation will have on their taxable income while making other time-sensitive decisions.
- Managing your capital gains and losses: Capital gains and losses offset. If a pass-through business has generated any capital gains or losses, there should be coordination with the ownership’s investment advisors to explore opportunities to harvest capital gains or losses in the ownership’s personal investment portfolio.
- Obsolete inventory: In general, manufacturers cannot take a deduction for obsolete inventory until it is physically disposed. If you have obsolete inventory that you have reserved for, dispose of it before the year-end to get the deduction.
- Research and Development Tax Credits: The R&D credit provides significant tax savings to a significant number of manufacturers. If your manufacturing company does not take the R&D credit, double check to see if you qualify. If you are already
taking advantage of the R&D credit, be sure to coordinate with your R&D expert regarding any changes in the laws and in your operations to maximize the credit.
- Explore creating an IC-DISC (Interest-Charge, Domestic International Sales Corporation): Manufacturers may be missing this lucrative U.S. tax incentive. Manufacturers that export (directly or indirectly) U.S. made goods may qualify for reduced tax rates on export profits. Because of the complexity involved with this tax strategy, many manufacturers are not taking advantage of this opportunity.
- Don’t forget the bank: These tax planning strategies, along with others, can’t be considered in a tax planning vacuum. As always, manufacturers need to consider any impact that these decisions would have on their debt covenants with their lenders. Tax planning time is the perfect time to also review your compliance with bank covenants since many financial covenants are measured at year-end. There can be opportunities to coordinate tax planning and covenant compliance decisions. One example is the timing of tax distributions. If a company is planning on a significant tax distributions to ownership in early 2017 to cover 2016 tax liability, and the company could make those distributions in 2016 while still being in compliance with their bank covenants, consideration should be given to accelerating those distributions into 2016.
These are just a few of the various tax opportunities out there. The key to keeping taxes low in April is to make sure your ducks are in a row by December. Be sure to coordinate with your financial and tax advisors to minimize your tax obligations.
By Brian Barsi
BRIAN BARSI, CPA, is a Managing Director at CBIZ MHM and a Shareholder of Mayer Hoffman McCann P.C., an independent CPA firm. Brian has extensive experience serving mid-market clients primarily in the manufacturing and distribution industries, and leads the CBIZ MHM Minneapolis Manufacturing group. He can be reached at 612-376-1237 or firstname.lastname@example.org.