Brian Murphy, Tax Partner – Consumer & Industrial Products Leader, Grant Thornton LLP
Dustin Stamper, Director, Washington National Tax Office, Grant Thornton LLP
There is great uncertainty as Congress and the White House prepare to tackle tax reform.
It’s unclear which of the myriad proposals will be included in the final reform plan, when exactly Congress will vote on the legislation, and when a new tax law will become effective.
Manufacturers hate uncertainty. Yet despite all the unknowns, businesses can take important steps now to prepare for tax reform, positioning themselves to take full advantage of the new tax laws before they are enacted.
The natural reaction amid uncertainty is to take a “wait and see” attitude. But rather than be paralyzed, manufacturers should adopt a pro-active strategy in anticipation of tax code changes.
There are many high-upside, low-risk strategies that need to be implemented before tax reform in order to be effective. Companies also shouldn’t make long-term business decisions without understanding the economic impact of tax reform. Management has a duty to its customers, employees – and in the case of public companies, shareholders – to understand how tax reform could affect business, and disclose the possible risks.
During a recent presentation, “The Outlook for Tax Reform in 2017,” tax specialists from the National Association of Manufacturers and Grant Thornton offered five steps the smartest manufacturers are taking now to prepare for tax reform:
One of the best moves manufacturers can take now is to run models to see how the various tax reform plans might affect their business. It begins by pulling last year’s tax return and running predictive models on the reforms most likely to be enacted.
Proposals most likely to survive include some type of corporate rate cut, a loss of some special credits and deductions, a one-time tax on repatriated earnings, and a shift to a territorial tax system. On the fence is a proposal for full expensing/loss of interest deduction.
Smart manufacturers are already studying these proposals and modeling their impact in order to identify planning opportunities and prepare to take quick action once a tax reform law is passed.
The Republican-controlled Congress proposes lowering the current 35% corporate tax rate to around 20%, with the top pass-through rate being 25%. President Donald Trump has called for lowering the corporate rate to as low as 15%. No matter the final figure, manufacturers should consider accelerating deductions against the current higher rate rather than lose savings when rates might be lower in the future.
Businesses can often control the timing of expenses, including compensation, bonus pools and benefit payments. Many large public companies have accelerated payments to retirement plans.
Manufacturers also should consider accelerating deductions in their building assets, which represent a large expense for many companies. All costs associated with a building do not necessarily need to be capitalized and depreciated over a 39-year schedule. Many building assets can be reclassified and depreciated using shorter lives, while other costs many qualify for an immediate deduction as repairs or maintenance.
Reviewing accounting methods
One of the best ways accelerate deductions and defer income is by reviewing accounting methods. Most companies use dozens of separate accounting methods on items ranging from inventory to software development. Identifying a better method often results in a favorable adjustment that is taken fully in the year of change.
Some of the best opportunities include deferring recognition on advanced payments or disputed income, and accelerating deductions for computer software, self-insured medical expenses, property taxes, payroll taxes, prepaid expenses and rebates.
The good news that even if a rate cut doesn’t happen, deferring income and accelerating deductions is always a good idea. It still provides a cash flow benefit and offers the time value of money. The possibility of a rate cut could turn timing changes into permanent benefits.
Calculating foreign earnings
Leading tax reform plans propose a one-time tax on unrepatriated earnings as part of a transition to a territorial tax system. Proposals range from a 10% tax on all earnings, to an 8.75% rate on cash and cash equivalents, and 3.5% on reinvested earnings.
Current rates are higher, but some manufacturers may actually pay less by bringing earnings home early and using foreign tax credits. The advantages can vary based upon the final legislation and each company’s unique tax situation. But forward-thinking companies are already assessing their foreign earnings and tax credits to gauge the cost of repatriating now compared to the cost under tax reform. Manufacturers should also consider accelerating deductions in its foreign subsidiaries using the same strategies discussed above. Shifting earnings so they are not recognized until after the one-time repatriation tax hits could provide a huge savings.
The impact of legislative changes aren’t recorded in financial statements until they take effect, but shareholders expect management to understand, plan for, and disclose risks. Companies with SEC disclosure requirements should consider whether to include a discussion of the potential impact of tax reform in the Management Disclosure and Analysis. Top publicly-held companies have already discussed with shareholders the potential impact of lower tax rates and the cost of repatriated earnings.
Understanding entity choice
The impact of tax reform will depend heavily on a how manufacturer is structured. The 25% rate for pass-through income proposed by House Republicans is already higher than the proposed 20% corporate rate, and that only tells part of the story. Republicans are looking for ways to prevent pass-through owners from converting compensation income into business income. They’ve discussed allowing just 30% of pass-through income to qualify for the lower rate, while 70% would be considered compensation taxed at the 33% individual rate. This would result in blended rate of 30.6%, putting some pass-throughs at a disadvantage.
Manufacturers organized as pass-throughs should prepare for an entity choice analysis by assessing future plans for distributing earnings and passing on the business. Manufacturers should also consider reaching out to local representatives to discuss all the ways higher pass-through rates might harm them.
The time is now
This is the best opportunity for significant tax reform in 30 years, and manufacturers need to be nimble and plan now for anticipated changes. Things could speed up quickly in Washington, or it could take longer than expected. But manufacturers need to be flexible and be ready to act.