Tax reform efforts in both the House and Senate contain important implications for manufacturers. On Thursday, November 16, House Republicans passed their version of the Tax Cuts and Jobs Act of 2017, a bill the National Association of Manufacturers (NAM) CEO and President, Jay Timmons, declared “a grand slam for hardworking manufacturers and the U.S. economy”.
In adjusting the rates and types of taxes that many manufactures and their owners pay, NAM believes the House bill would help grow jobs and increase economic growth. Specifically, the House bill lowers the existing corporate tax rate from 35% to 20%, effective in 2018. It likewise proposes to eliminate the corporate alternative minimum tax in full and creates a new 25% percent maximum tax rate on pass-through business income, subject to certain anti-abuse rules. For example, to prevent abuse, those owners who actively participate in their business would be subject to the 70/30 rule: 70% of their income from the business would be taxed as ordinary income at rates as high as 39.6% with the remaining 30% of would be taxed at the 25% preferential rate.
The Senate’s plan also seeks to reduce taxation. Like its House counterpart, the Senate would lower the corporate tax rate to 20% (but not until after 2018) and eliminate the corporate alternative minimum tax in full. Unlike the House bill, however, the Senate’s plan does not lower the pass-through rate of taxation, offering instead a 17.4% deduction for domestic qualified business income for pass through entities
The House bill also calls to move the United States toward a “territorial tax system.” In this framework, most U.S. businesses would not be taxed on future foreign earnings and dividends, but instead be subject to a one-time, deemed repatriation tax at rates of 14% on cash and 7% on non-liquid investments on previous, deferred foreign earnings. The Senate bill contains provisions for a similar repatriation tax at 10% and 5%, respectively.
The House bill makes changes to certain manufacturer deductions, including elimination of the Section 199 manufacturing deduction and certain like kind exchanges. The bill also limits: (1) the business interest deduction to 30% of adjusted taxable income (essentially tax EBITDA) with any excess carried forward five years; and (2) net operating losses to 90% of taxable income for a given year, with the excess to be carried forward indefinitely. The ability to carryback net operating losses to previous tax years is generally repealed.
The Senate’s plan follows along similar lines but with some modification. Like the House bill, the Senate calls for elimination of the Section 199 deduction and limits the deductibility of interest expense and certain like-kind exchanges. It also restricts the use of net operating losses to 80% of taxable income, adding that net operating loss carrybacks would not be permitted after 2022. Finally, the Senate eliminates the Interest Charge Domestic International Sales Corporation provision (IC-DISC) that provides exporters the ability to tax certain income at qualified rates. The House bill does not address the IC-DISC.
To compensate for these removals, the House provides for an increase in deductions related to investment in capital asset purchases. Specifically, for tangible personal property placed in service after September 27, 2017 and before January 1, 2023, the House bill would increase the first year additional depreciation deduction (“bonus depreciation”) from 50% to 100%. The Senate’s plan follows the House in that regard.
The House bill also includes an increase to Section 179 expensing of qualified property. Effective for tax years 2018 through 2022, the House bill would increase the deduction from $500,000 to $2 million, as well as the investment phase out threshold from $2 million to $20 million. The Senate’s version also calls for an increase to Section 179 expensing up to $1 million and the phase out threshold to $2.5 million plus an expanded definition of property that qualifies for Section 179 expensing.
Both plans call for preservation of the research and development tax credit, but both require the capitalization of research and development expenditures with a five-year amortization in future tax years. Both plans versions also propose changes to the UNICAP rules.
There are many provisions within the House bill and Senate plan that will have an impact on manufacturers. Schneider Downs is dedicated to monitoring tax reform and keeping you informed. Please review our Tax Reform Blog that monitors these bills as they work through the legislative process. For more information on tax reform and its impact on the manufacturing industry, contact us.