The 2022 Tax year is swiftly coming to an end. Taxpayers should be on the lookout for three provisions effective January 1, 2023 which could have a significant impact on entity returns for the manufacturing industry; (1) the Tax Cuts and Jobs Act (TCJA) of 2018’s amendment to §174, (2) the Internal Revenue Code (IRC) §163(j) business interest expense deduction limitation modifications, and (3) a start to the phase out of bonus depreciation.
The TCJA amendment to §174 will have a direct impact on research and development (R&D) expenditures incurred during the 2022 tax year. Companies incur R&D costs to innovate and design new products and services or improve the efficiency of existing systems. According to the § 174 amendment, R&D costs must be capitalized and amortized over a five-year period for domestic expenditures, and amortized over a 15-year period for foreign-related costs. Prior to this provision, companies were allowed the option to expense these costs during the year they were incurred. Companies may want to consider claiming the R&D tax credit to offset any increased tax liability due to the amendment if they have not already done so in the past.
The IRC § 163(j) interest deduction limitation has been in place since the 2018 tax year, but the calculation is changing in 2023. It is important to note that the provision does not generally impact small businesses with average annual gross receipts of $26 million or less for the 3 previous tax years. For larger entities, this provision eliminates the add-back of depreciation and amortization expenses to calculate Adjusted Taxable Income (ATI). Prior to the limitation, companies could leverage a higher ATI to maximize their deduction. Since business interest expense is deductible by up to 30% of ATI, companies that utilize loans to cover the costs of operations may notice an increase in their entity’s tax burden. Many manufacturing companies rely on business loans and leases to fund the purchase of equipment, maintain operations and facilitate growth.
Lastly, the phase-out of bonus depreciation comes into effect beginning in the 2023 tax year, and it may impact your business’s purchasing decisions regarding capital assets. Bonus depreciation allows companies to immediately deduct an asset’s purchase price rather than writing the expense off over the asset’s useful life. Before the 2022 tax year comes to an end, businesses are allowed to take 100% of the asset’s depreciation deduction during the year it is placed in service. This benefit will decrease by 20% every year until the provision sunsets in 2027. Bonus depreciation is limited to qualified property and may require an addback on your state returns if that state decouples from the federal provision (including New York). Qualified property generally includes any property with a recovery period of 20 years or less. Companies in the manufacturing industry may want to take advantage of this opportunity to offset the high costs of equipment purchases while it is still in effect.
If you would like to better understand the impact these changes may have on you or your business, please contact your TBC Advisor to navigate the best options for you.