Many tax updates and changes affecting the manufacturing and distribution (M&D) industry occurred in 2023 and now there are new rules and regulations that will need to be met.

CohnReznick’s M&D tax team has compiled the top tax topics and issues that those in the M&D space need to know.

IRS Interest Rates for Quarterly Payments 

by Mike Nudge, Manager

Failure to pay federal corporate income tax estimates on a quarterly basis throughout the year could result in penalties and interest computed on the underpayment. For the calendar quarter beginning Jan. 1, 2024, the interest rate used for federal corporate income tax underpayments will be 8%. For large corporations, the interest rate will be 10%. The IRS defines large corporations as follows: A corporation (other than an S corporation) that had, or whose predecessor had, taxable income of $1 million or more for any of the three tax years immediately preceding the taxable year for which estimated tax is being determined (the current taxable year), or, if less, the number of years the corporation has been in existence. Given that the IRS typically uses rates three to five percentage points over the federal short-term rate to compute interest on underpayments, it is important to have quarterly discussions with your tax advisor. 

IRC 174 – Amortization of Research and Experimental Expenditures

by Daniel Coriddi, Senior Manager

The 2022 tax year saw major changes in the treatment of taxes for research and experimental costs with the implementation of Code Section 174. Taxpayers and practitioners went most of the tax compliance season with little guidance on how to address this tax law change which called for the capitalization and amortization of research and experimental costs with a recovery period of five years (or 15 for foreign incurred costs). Finally, in early September 2023, the IRS issued Notice 2023-63 which provided much needed guidance but left little time before the final tax deadlines. 

Now as the 2024 filing season begins – the proposed Tax Relief for American Families and Workers Act of 2024 would again change the treatment of R&E expenses. The proposed deal, which has bipartisan support, would allow taxpayers to deduct currently domestic research or experimental costs that are paid or incurred in tax years beginning after Dec. 31, 2021, and before Jan. 1, 2026. Foreign expenses would still have to be capitalized and amortized over 15 years. It is currently unclear what the mechanics are for going back and making this change retroactively. 

Given that the bill has yet to pass, below are some observations from the September 2023 guidance issued that taxpayers should be aware of while completing their 2023 Section 174 calculations.  

Overhead Costs

The IRS notice clarified that overhead costs related to research and experimental costs would also have to be capitalized. This includes rent, utilities, insurance as well as other compensation related costs such as pensions, share-based compensation, and payroll taxes. While it was not specifically prescribed in the notice, the support and documentation to support a tax position is key in order to allocate these costs in a tax efficient manner. This support could include additional ledger accounts and new internal accounting policies. 

Development vs. Maintenance

One area of opportunity for tax planning outlined by the notice are costs NOT considered qualified research and experimental costs. The notice clarified that costs related to “maintenance activities after the computer software is placed in service that do not give rise to upgrades and enhancements” would not need to be capitalized. This means that even if an employee works in the R&D department not all of their salary and associated overhead costs would need to be capitalized. Again, it is important to document this allocation as guidance for this allocation was not provided. 

Employee Retention Credit (ERC)

by Christopher Padulano, Senior Manager | Dana Fried, Managing Director

Over the past several months, the IRS has issued additional guidance in connection with the Employee Retention Credit (ERC) out of its concerns that invalid ERC claims have been made by many employers, often upon the advice of overly-aggressive “ERC consultants”. The IRS has provided employers with the penalty-free opportunity to voluntarily withdraw any ERC claim not yet subject to IRS audit, provided that ERC amounts have not yet been paid or, if paid, have not yet been deposited by the employer. In addition, for employers that did receive and deposit ERC checks, the IRS has provided a limited opportunity, through March 22, 2024, only, to repay 80% of the ERC amounts without penalty (the employer can also retain any interest paid in connection with the ERC claims). Unless withdrawn or repaid, employers that file ERC claims are required to reduce their income tax deductions previously taken for the wages and health plan expenses used to generate their ERCs, either by amending the return for the year in which those amounts were paid or, in the case of certain partnerships, by use of an Administrative Adjustment Request.

IRC 168(k) – Bonus Depreciation

by Kim Baker, Manager

Bonus depreciation is accelerated depreciation allowed on eligible assets, such as machinery and equipment, furniture and fixtures, and qualified improvement property. In 2022, taxpayers were allowed to deduct 100% of the eligible costs on qualified assets purchases. Beginning in 2023, that deduction decreased to 80% and will continue to be reduced by 20% a year in each subsequent year until the bonus depreciation deduction is fully phased out in 2027. The recently proposed Tax Relief for American Families and Workers Act of 2024 would look to extend the 100% bonus provisions of TCJA. If passed, businesses would be able to take 100% bonus depreciation on qualified property placed in service after Dec. 31, 2022, and before Jan. 1, 2026

IRC 163(j) – Interest Expense Limitation

by Dennis Cosme, Senior Manager

Federal change of interest expense limitation: 

As of 2022, the computation of Adjusted Taxable Income (ATI) has changed and no longer includes adjustments related to depreciation and amortization. Without such inclusion of depreciation and amortization in the ATI base, more taxpayers are now subject to additional interest expense limitations triggering more interest expense carryovers which can only be deducted when the entity has sufficient ATI at some point in the future.  There are certain states, however, that have either modified and/or decoupled from the IRC 163(j) provisions all together which would allow the taxpayers to deduct interest expense as it is incurred for state income tax purposes.

The recently proposed Tax Relief for American Families and Workers Act of 2024 would reverse the 2022 change of the depreciation and amortization adjustment retroactively. 

ASC 740 (Accounting for Income Taxes): Hot Topics

Federal

Management will need to consider these tax law changes as many will experience significate increases of their company’s deferred tax assets (DTA) and/or would need to consider initially booking such assets for the very first time. Obviously, these tax law changes will also have an impact on how management goes about assessing the need to either book, retain, and/or release a valuation allowance and consider the impact of the Naked Credit, if any.

States

Certain states have either modified the IRC 163(j) provisions and/or have decoupled. Thus, taxpayers will need to understand the adverse impact of DTAs as the interest expense carryovers become material in nature for US GAAP reporting purposes. Accordingly, for taxpayers conducting activities in states which have decoupled from IRC 163(j), considerations and assessments will need to be made as this may trigger “a contra DTA.” Once the interest expense carryovers and DTAs have been recovered, taxpayers will need to reverse these benefits on the states which decoupled from IRC 163(j) and provide for state income taxes.

Proposed Legislation

The Tax Relief for American Families and Workers Act of 2024(“Act”) would have a significant impact on all taxpayers, but particularly those in the manufacturing and distribution industry. The main business provisions the bill updates are very common tax areas for these companies.  

It is important to note that financials and corresponding tax provision calculations must be prepared as the law has been enacted as of Dec. 31, 2023. Thus, even if the passing of the bill is eminent, calculations and reporting must still conform to Section 174, 168(k), and 163(j) as they are currently written. Once the bill passes and is enacted, tax returns can be prepared to reflect any retroactive legislation. Financial statements issued may include a subsequent event disclosure to detail the impact these proposed changes would have on the company.

Finally, under the proposed Act, the filing deadline for retroactive Employee Retention Credit (ERC) claims would be moved up (from April 15, 2024, for 2020 claims and April 15, 2025, for 2021 claims) to Jan. 31, 2024. In this regard, it is noteworthy that the Act would also extend the statute of limitations period to permit employers that voluntarily withdraw or repay their ERCs to re-amend their income tax returns to reverse the reduction of their income tax deductions as had been required with respect to their ERC claims.