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2015 Year-End Tax Planning and Preparation Tips for Manufacturers and Distributors
Here comes a new year — and with it another tax season. That means it’s time to examine your manufacturing or distribution company’s tax plan and draw together the most advantageous strategy for 2015 filings, as well as look at what’s ahead in 2016. Here’s a checklist of items that will help you comply and find the greatest possible tax savings for both your business and your family.
Though Congress has yet to enact new tax legislation, we believe something will likely be decided in the coming weeks, with possible changes retroactive to January 1, 2015. We anticipate the 2015 tax provisions will increase the Section 179 or bonus depreciation limits (discussed below) and also reinstate some expired tax provisions that are generally renewed on an annual basis.
Affordable Care Act
The Affordable Care Act will affect many manufacturers and distributors in 2015 and beyond. There are new reporting rules that require additional filings due January 31, 2016. Companies with at least 50 employees (counting full-time and full-time equivalents) will have to complete Forms 1095-C for all of their full-time employees, together with a related Form 1094-C for the company. Some with fewer than 50 employees may have to file Forms 1095-B and 1094-B if they partially self-insure employee health care. These filings are complex and require a lot of information, and you will likely seek professional assistance to comply. The non-compliance penalties are quite severe, so be aware of your obligations.
Cost segregation of buildings or improvements
Any building acquisition, construction project, or renovation which costs more than $500,000 can usually defer tax liabilities and provide a cash flow benefit through some form of a cost segregation study. These studies separate the various costs of the structures and land improvements into different depreciation methods and shorten the depreciable life categories, which accelerate your tax deduction for depreciation. The tax depreciation may be greater than the book depreciation methods used for your financial statements.
Interest charge-domestic international sales corporation
Manufacturers and distributors that export can significantly reduce their federal tax bill by creating an interest charge-domestic international sales corporation (IC-DISC). It’s a long name, but the concept is quite simple. The IC-DISC is formed, and the U.S. exporter pays an annual, tax-deductible commission on its export sales to the IC-DISC. The IC-DICS pays no U.S. income tax on the commission income, and the earnings are repatriated to the IC-DISC shareholders and taxed at the favorable dividends rate, which can be significantly lower for some shareholders.
The IC-DISC implementation strategy is a time-sensitive issue in that only the export sales following the formation of the DISC qualify for the benefits. Therefore, if you anticipate export sales in 2016 or are contemplating a global initiative for your manufacturing business, you should strongly consider contacting your tax professional to discuss an IC-DISC strategy.
Research and development credit
If your company designs products or has improved its production processes, there is a good chance that you may be eligible for a tax credit associated with the expenditures, wages, and other costs related to research, development, and other qualifying activities. The tax definition of research and development (R&D) includes much more than just scientists in lab coats. In fact, many companies are surprised to find that more than a few of their activities qualify for the R&D credit. Make sure to take a close look at all of your activities for 2015 and consult with your tax professional to discuss those that may qualify for the credit.
Though Congress has yet to enact legislation that would extend the credit to 2015, we believe something will likely be decided in the coming weeks that would extend the credit retroactively to January 1, 2015 and beyond, with a good possibility of it becoming permanent.
Section 199 domestic production activities deduction (DPAD)
DPAD is an attractive savings opportunity for U.S.-based companies that engage in qualifying production activities. The DPAD is equal to 9 percent of qualified production activities income and is applicable to a wide variety of qualifying activities associated with manufacturing, producing, growing or extracting that result in permanent tax savings.
Manufacturers should take a close look at all of their lines of business and associated activities to determine if any meet the qualifying DPAD criteria in order to maximize the benefit and adequately document the calculation.
S corporation or partnership losses
If you own an interest in an S corporation, you may need to increase your tax basis in the entity so you can deduct a current-year tax loss against other income. If you are reporting losses, you should review the tax basis in your company’s stock, as well as the tax basis in loans to the company, to ensure that you have sufficient tax basis to deduct the loss on this year’s personal income tax returns. These strategies may require adjustment prior to the end of 2015.
S corporation owner’s health insurance deduction
Based on a directive from the IRS, it is important that the corporation pay the health insurance premiums of an S corporation shareholder or reimburse the shareholder for premiums paid personally, in accordance with a corporate plan. Those premium payments must be added to the owner’s Form W-2 as taxable wages. This allows the individual owner to claim a deduction for the health insurance costs. The income added on Forms W-2 is not subject to FICA or Medicare.
Joint taxpayers with combined earned income in excess of $250,000 will be subject to an additional 0.9 percent Medicare tax in 2015. Consider your wages for 2015 and 2016 to determine if it is possible to reduce your wages to below this amount. For many S corporation owners who are planning on receiving wages more than a reasonably-low amount, it may be worthwhile to determine whether you can reduce wage payments and instead take S corporation distributions to avoid this additional tax. Wages, however, must be reasonable for the services provided.
Do you lease real estate to your own business entity? If so, the passive activity loss rules present a significant threat. If your Form 1040 has a mix of positive and negative net income amounts among your rental activities, the passive loss risk needs to be carefully assessed. Grouping rules may allow you to offset your rental losses with company profits to avoid disallowance of the losses.
Officer note payable repayments
If your company or another business entity has generated taxable losses in the past, review current-year loan repayments made to shareholders. If prior-year losses have been taken based on money borrowed from shareholders, the repayment of such loans may create taxable income to the shareholder in the year of repayment. Review your loan activity in 2015 and consult with a tax advisor to determine if an unwelcome tax surprise may result.
Capitalize or expense repairs?
Generally, most manufacturers’ and distributors’ fixed assets are capitalized and depreciated over a number of years. The regulations in place now may allow manufacturers to expense items that you would have depreciated in past years. Effectively implementing these capitalization policies will allow you to expense items that cost less than $2,500, and may allow for expensing items up to $5,000. This can really benefit a manufacturer or distributor and should be looked at closely.
Section 179 expense and bonus depreciation
For 2015, the Section 179 first-year expense deduction is reduced to $25,000. This is down significantly from the $500,000 amount allowed in recent years. This allows a manufacturer to purchase up to $25,000 of new or used equipment, furniture, or fixtures by year-end and expense the entire purchase price to the extent of taxable income. Once total expenditures for such assets exceed $200,000, the amount of available Section 179 expense begins to phase out.
Planning note: We believe that the Section 179 expense limit will be increased for 2015. Unfortunately, we may not know how much will be allowed until the very end of this year or perhaps sometime next year (and made retroactive to 2015). Bills in Congress suggest that Section 179 expense of $500,000 is likely. Planning for use of this deduction and its effect on your company should be reviewed closely at year-end. The total expenditure phase-out is likely to increase to $2 million.
In prior years, in addition to Section 179 expensing, there has been the ability to write off 50 percent of all new equipment in addition to the Section 179 expense allowance. Unfortunately, there is currently no bonus depreciation for 2015.
Planning note: Similar to Section 179, bonus depreciation may be reinstated for 2015. Unfortunately we will not know until legislation is passed.
Net investment income tax
The net investment income tax is 3.8 percent again for 2015. For manufacturers and distributors at the top marginal tax rate, this could equal a tax rate of 43.4 percent. This is a tax on interest, dividends, rental income, capital gains, and passive income. Through the use of grouping elections, changing interest rates on shareholder loans and other planning to reduce capital gains, it may be possible to reduce your income subject to this 3.8 percent additional tax. In a change from what many expected, the additional 3.8 percent tax does not apply to net rental income generated from the manufacturing or distribution company renting its building from the business’s owner.
Review customer accounts receivable to determine which past-due accounts are uncollectible. You can claim deductions for bad debt expense.
Meals and entertainment expenses
Many manufacturers and distributors lump all meal and entertainment expenses into one account. As a result, most of these expenses will only have half of the expense deducted on the company’s tax return. Such expenses should be reviewed by company personnel to identify meals and entertainment that may be 100 percent deductible.
Don’t forget to accumulate information needed with regard to interest income, rent, and payments to independent contractors. All Forms 1099 (and the aforementioned Forms 1095-C) to report these payments must be provided to payees by January 31, 2016; the government copy of these forms must be sent into the government by February 29, 2016.
Review January expenses
Taxpayers are usually encouraged to review their expenses paid in January to determine if they are properly deductible in 2015. With the significant tax rates many manufacturers and distributors will face this year, you will want to review all January and February invoices to find those that can be deducted in 2015.
Maximize contributions to your 401(k) and other retirement plans
Many manufacturers and distributors have instituted retirement plans so employees can make contributions to reduce the employees’ wages. Most of these plans have limits on the amounts that officers and owners of the company may contribute (and sometimes require that such contributions are returned at year end). However, owners frequently do not contribute the maximum amount. After the year ends, the opportunity to contribute more is missed. Contact your retirement plan administrator to determine if you can contribute additional funds to these accounts.
Compensate children for work
If your children provide, or could provide, services to your company, consider the benefits of paying them for their services. This may introduce them to the idea of working to earn compensation. At the same time, it may reduce your overall family tax burden based on tax rate differences. The wages earned by the children could be contributed to a Roth IRA for lifetime tax-free growth.
Gift and estate taxes
You can save gift and estate taxes by making gifts covered by the annual gift tax exclusion before year-end. You may give $14,000 each to an unlimited number of individuals in 2015 to reduce the costs of a 40 percent federal estate tax to your heirs. However, you cannot carry over unused gift exclusions from one year to the next. For those with children or grandchildren that may be facing future higher education costs, talk to an advisor about designing a gift strategy that uses tax-free Section 529 college savings plans.
Itemized deductions and dependent exemptions
Higher-income taxpayers with income over approximately $310,000 (married) or $258,000 (single) will lose some of their dependent exemptions, as well as itemized deductions. At certain income levels, this can result in a loss of up to 80 percent of itemized deductions. This means that some manufacturers and distributors should consider accelerating or deferring a portion or all of their charitable contributions and/or state income tax payments normally made before year-end.
Harvesting capital gains or losses
If you have unrealized gains or losses in your stock portfolio, there is a potential to use them for 2015. If your income is low for 2015, it might make sense to recognize gains, pay the tax at a lower rate, and then repurchase similar holdings. If your income is already quite high for 2015, consider recognizing those losses to reduce your tax liability and then repurchase similar holdings. Because of the wash sale rules, you have to be careful. However, there are ways to harvest losses without triggering the wash sale rules. If this is applicable to you, please let your tax advisor know, as the sale has to occur in 2015. Likewise, if you already have carryover capital losses from previous years, you could harvest gains in order to offset those losses, as you can only deduct a net loss of $3,000 per year.
Charitable donations of appreciated stock
Another way to minimize tax on capital gains is to directly donate appreciated stock. There are multiple benefits, such as deducting the higher, appreciated value of the stock as opposed to its original cost basis. Plus, there is no income recognition on the donation of the appreciated stock.
Recognize income in 2015 or 2016
Consider postponing income to the following year for tax deferral, if possible. Taxpayers with income in excess of $400,000 should review current-year income compared to expected income for 2016 to see if taxable income should be maximized in 2015 or deferred. Married taxpayers should expect income over $465,000 to be subject to the highest federal tax rate of 39.6 percent. The effective rate, due to phase-outs of deductions for high-income individuals, may be higher. For singles, the threshold income is about $413,000.
How we can help
Our manufacturing industry tax practitioners can help you both comply and maximize tax savings for your business and yourself. We can work with you to develop a strategic tax plan and help make sense of complex regulations and rules.