Many taxpayers in the manufacturing and distribution sector were left uncertain going into the 2023 tax filing season. Many taxpayers expected Congress to pass legislation that would repeal the requirements to capitalize Specified Research or Experimental (SRE) expenditures under Internal Revenue Code (IRC) Section 174. In the absence of Congressional action prior to initial due dates for federal tax filings, most manufacturers opted to extend their federal filings in hopes that Congress would act before the extended due dates of Sept. 15 and Oct. 15 (for calendar year-end entities). During the summer months, manufacturers and distributors should take advantage of the time to properly plan for compliance with Section 174 as well as other tax matters relevant to those in the manufacturing and distribution industries.

Section 174

Prior to the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers, including manufacturers and distributors, could immediately deduct research and experimental (R&E) expenditures as incurred pursuant to Section 174. The enactment of TCJA eliminated manufacturers’ ability to deduct R&E expenditures paid or incurred in tax years beginning after Dec. 31, 2021. As a result, manufacturers and distributors now must capitalize domestic R&E expenditures over a five-year period and foreign R&E expenditures over a 15-year period. The IRS has recently released guidance in the forms of Notices and Revenue Procedures to aid taxpayers with the computation of SREs while also providing administrative and procedural mechanisms to effectuate the change in law. In early 2024, the House of Representatives passed the Tax Relief for American Families and Workers Act of 2024, which called for a reinstatement of immediate expensing of domestic SRE expenditures. Following bipartisan passage in the House, the bill has since stalled in the Senate with a diminished hope for passage in 2024.

As of the date of this writing, manufacturers and distributors should consider proceeding with computing SREs utilizing the current laws. Additionally, manufacturers and distributors should explore the possibility of claiming the R&D credit, which can be a useful tool to offset any detrimental effects on tax liabilities resulting from implementation of Section 174.

Fixed Assets

The TCJA implemented, among other beneficial provisions, bonus depreciation of 100% for assets placed in service from Sept. 27, 2017, through Dec. 31, 2022. The bonus depreciation rate decreases by 20% each year until it fully phases out for tax years beginning on or after Jan. 1, 2027. For 2024, the bonus depreciation rate is 60%, which impacts the first-year depreciation benefit manufacturers and distributors can expect for assets placed in service during the year. To mitigate this decreased benefit and subsequent increase in taxable income, those in the manufacturing and distribution industry should consider implementing one of the following fixed asset related tax strategies prior to year-end:

• Section 179: Eligible property may be fully expensed in the year of purchase, up to a maximum of $1,220,000 for 2024.
• Cost Segregation Studies: A cost segregation study provides an opportunity for manufacturers and distributors to accelerate their depreciation deductions by identifying assets classified as 39-year real property and reclassifying those eligible assets into a more advantageous tax asset life under the Internal Revenue Code.
• Tangible Property Regulation (TPR) Analysis: Provides for immediate expensing of certain expenses incurred to preserve the functionality or appearance of facilities or equipment. TPR studies can also be performed on assets placed in service during the current year or in a previous year via a “look-back” study.

Section 263A – UNICAP

In November 2018, final regulations were issued by the Internal Revenue Services which provided for a new modified simplified production method (MSPM) for determining the additional costs allocable to property produced for resale. These final regulations modified the old Simplified Production Method and under many circumstances may provide for a more beneficial result for many manufacturers and distributors.

Manufacturers and distributors subject to the uniform capitalization (UNICAP) rules must capitalize all direct costs and an allocable portion of some indirect costs that are associated with their production activities. These rules apply to real or tangible personal property produced by the taxpayer for use in a trade or business, or produced by the taxpayer for sale to customers. All manufacturers and distributors with inventory on hand at year-end are subject to UNICAP unless certain exemptions apply. Of the exemptions provided for in Section 263A, perhaps the most common is found in Section 263A(i), which provides an exemption for small business taxpayers who fall under the gross receipts test found in Section 448(c). For 2024, manufacturers and distributors with average gross receipts of greater than $30,000,000 for the three taxable-year periods of 2021, 2022, and 2023 – but who have not previously computed a UNICAP adjustment due to being classified as a small business taxpayer under Section 448(c) – will be required to compute an adjustment under Section 263A. Manufacturers and distributors should be mindful of their gross receipts, which will potentially include the receipts of related entities, for this rolling three-year period to ensure compliance with the requirements of Section 263A.

What does CohnReznick think?

The ongoing Congressional discussions related to legislation that could impact both Section 174 and bonus depreciation continue to leave taxpayers uncertain about the tax landscape for both 2023 filings and those for tax year 2024. Manufacturers and distributors should be mindful of UNICAP, as well, considering the IRS has recently increased enforcement of Section 263A in recent audits. Each of these issues present unique risks to those in the manufacturing and distribution industry. CohnReznick is here to assist with these and any other tax matters with which you may need assistance.

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}