So far we have covered some key contributors to a manufacturer’s bottom line performance. Having a firm grasp on tax savings tactics will also help ensure that you hit those performance numbers you need to further grow your operation. In this final chapter, we offer five of them.
1) Export Tax Savings through an IC-DISC
If you own a profitable business that is exporting items that are at least 50% manufactured in the U.S., you could be eligible for significant tax savings through a separate entity called an Interest Charge Domestic International Sales Corporation (IC-DISC). While the IC-DISC entity classification has been around for a while, many U.S. exporters have failed to take advantage of the opportunity, or aren’t even aware that they qualify. Here are questions that will help you determine your eligibility:
- Do you export or sell to a U.S. customer that exports product manufactured with the U.S.?
- Does the export have less than 50 percent of its value made of imported components?
- How much are your export sales? Are they profitable and if so, what is the approximate profitability of those sales?
As a separate legal entity acting as a “selling agent” for your operating business, the IC-DISC has multiple tax-savings benefits:
- Sales commissions paid to the IC-DISC are tax deductible to the operating business
- The IC-DISC is a tax-free entity , so the taxable income it earns escapes taxation
- Dividends paid to the shareholders are taxed at favorable dividend rates—20%
- Profits may be accumulated for estate planning
- Income can be shifted to lower tax bracket taxpayers
- IC-DISCs can work with C-corps, S-corps, LLCs or partnerships
One last note—if your product is a component that you sell to a distributor, as long as that distributor sells the final product to a foreign country under the rules described above, you can still create take advantage of IC-DISC tax savings
2) Research and Development (R&D) Tax Credit
The federal R&D Tax Credit helps boosts competition by allowing companies to take a dollar-fordollar reduction of federal and state income taxes for qualified expenditures associated with the development of or improvement of a product, process, formula, invention or software.
R&D tax credits are available to your company if you increase your qualified research spending for new products and services. This includes new companies, existing companies embarking on R&D for the first time and established companies expanding their R&D budget. You can carry forward any unused R&D tax credits for up to 20 years.
Business entities that do not pay federal income tax, such as S corporations and partnerships, are permitted to “pass-through” their tax credits to shareholders or partners, who can use the federal R&D credit as long as their tax liability doesn’t dip below the Alternative Minimum Tax (AMT).
Many states, including Ohio, offer the R&D Tax Credit which generally follows the federal regulations and IRS guidance on what constitutes qualified research expenditures (QREs). Each state uses a different approach to calculate the R&D credit;
If you’re filing a Form 6765 (Credit for Increasing Research Activities) for your business entity, you are most likely eligible for an R&D credit against your CAT as well. Keep in mind that the CAT is a tax based on Ohio gross receipts, not net income. Therefore, even if you are not able to use the R&D credits on a federal level due to net operating losses, you may still have an Ohio CAT liability and can use the credit against this tax. Any R&D credit in excess of your current period CAT can be carried forward seven years.
3) InvestOhio: Investment Support for Ohio Manufacturers
Ohio’s Development Services Agency made it easier for manufacturers to grow by developing the InvestOhio program, creating a 10% nonrefundable income tax credit up to $100 million that provides investors support for their investment.
If you are considering one of the following actions this year, you may qualify for the InvestOhio tax credit program:
- Purchases of fixed asset
- Hiring new employees
- Expanding your business
Requirements to qualify for the InvestOhio tax credit include:
1. The small business is required to invest new equity into the business and spend it on one of five categories of allowable expenses within six months of its receipt.
a. Tangible Personal Property, excluding personal use vehicles, used by the small business
b. Motor vehicles registered in Ohio and used primarily for business purposes by the small business
c. Real property located in the state used in the small business
d. Intangible personal property (i.e., trademarks, patents, licenses, etc.) used by the small business
e. Compensation for new or retained employees subject to Ohio withholding tax
2. The investor must retain his or her equity contribution in the business for a two-year holding period before the tax credit may be claimed
3. The small business must similarly retain the property that it purchased from the cash infusion for the entire two-year holding period
Once approved, the credit can be carried forward over the following five tax years. InvestOhio is funded through June 30, 2017.
4) Domestic Production Activity Deduction (DPAD; Sect. 199 Deduction)
When the American Jobs Creation Act of 2004 was enacted, it included a tax relief provision for domestic manufacturers with the intent of stimulating U.S. manufacturing activity. A business that is profitable that does any manufacturing, with a significant part of its taxable income generated from “production” activities in the United States, may qualify for a deduction equal to 9% of its qualified production activity income (QPAI). As a safe harbor, the significance requirement can be met if the taxpayer’s direct labor and overhead for the qualified production within the U.S. is 20% or more of the product’s total cost.
Understanding the complex rules that govern the QPAI calculation is critical in maximizing available tax deductions. If your business has claimed the Domestic Production Activity Deduction (DPAD or Section 199 Deduction), check the Form 8903 filed with your tax return. If the amount on line 10b is less than taxable income there may be opportunities for more DPAD than claimed. Even if your business passes that simple test, there may be even more deduction lurking under the surface of the calculation itself.
If you are a partner or S-corporation shareholder in a manufacturing business and your Form K-1 does not show information for you to compute the DPAD on your personal tax return there also may be an opportunity for the business to claim the DPAD.
5) Last In First Out Inventory Valuation (LIFO)
LIFO has been around for ages, yet many manufacturers do not take advantage of this beneficial accounting method. LIFO is especially beneficial in environments of rising inventory levels raw material experiencing constant inflation. When using the LIFO method, inventory is valued at prior year amounts, which could be decades old, and significantly lower than today’s dollars. When inventory levels are lower, cost of goods sold expense is increased, thereby lowering taxable income. The only additional requirement for using LIFO to decrease your tax bill is that it must be used for financial statement purposes as well.
Looking to take the next steps in your manufacturing business? Download our free e-book, Overcoming the Challenges of Today’s Manufacturer, for more great insights on how you can improve your bottom line.
For more information about how to save on your taxes or grow your manufacturing business, please contact Jon Shoop at 440-605-7107 or jshoop@skodaminotti.com.
