The manufacturing industry is a vital component of the global economy, with factories and assembly lines producing everything from basic goods to high-tech products. However, despite its importance, many manufacturers are facing significant challenges when it comes to profitability.
Increasing competition, rising costs, and changing consumer demands are just a few of the factors that are putting pressure on manufacturing companies to find ways to improve their bottom line.
One of the most effective ways for manufacturers to improve profitability is to increase efficiency. This can be accomplished through a variety of means including automating processes, streamlining supply chains, and implementing lean manufacturing techniques.
One example of automation in manufacturing is the use of robotics. Robotics can be used to perform repetitive tasks quickly, accurately, and consistently.
They can also be programmed to operate 24/7, resulting in increased productivity and reduced labor costs. By reducing the need for human labor, manufacturers can lower their costs while increasing output.
Lean manufacturing is another approach that can help manufacturers increase efficiency. This method focuses on reducing waste and maximizing value.
By identifying and eliminating unnecessary steps in the manufacturing process, manufacturers can improve productivity and reduce costs.
Effective supply chain management is critical to profitability in the manufacturing industry. By improving the way they manage their supply chain, manufacturers can reduce costs, improve efficiency, and increase customer satisfaction.
One way to improve supply chain management is with advanced analytics. By analyzing data on supplier performance, production schedules, and inventory levels, manufacturers can identify bottlenecks, inefficiencies, and areas for improvement.
Additionally, many of the advanced analytics solutions that are currently available are able to use machine learning techniques to detect patterns and anomalies, which can help manufacturers make more informed decisions.
Another way to improve supply chain management is through the use of technology such as RFID or barcode scanning.
These technologies make it possible to track the movement of goods through the supply chain in real-time, which can help manufacturers identify issues and opportunities for improvement.
Diversifying products and services is another key strategy for improving profitability in the manufacturing industry. By offering a wider range of products and services, manufacturers can reduce their dependence on a single product or market and increase their overall revenue.
For instance, a manufacturer of consumer goods can also move to provide consumer services, such as repair and maintenance of the product, which can increase their overall revenue.
In addition to diversifying products and services, manufacturers can also look for new markets to expand into.
For example, a manufacturer of industrial products can look to expand into the consumer market, or a manufacturer of consumer goods can possibly expand into international markets.
Investing in research and development (R&D) is another important strategy for improving profitability in the manufacturing industry. By developing new products, processes, and technologies, manufacturers can stay ahead of the competition and increase their market share.
For instance, a manufacturing company can invest in research and development to devise a sustainable solution to reduce their carbon footprint, which in turn can attract more customers who are environmentally conscious.
However, it’s worth noting that investing in R&D requires a long-term commitment and a significant amount of resources. Manufacturers need to carefully evaluate their R&D investments to ensure they are yielding the desired results.
Quality and safety are critical for manufacturers to maintain their reputation and improve profitability. By emphasizing quality and safety, manufacturers can improve customer satisfaction.
Manufacturers should always look for ways to get the most tax bang for their buck. One proven method is to maximize tax breaks relating to depreciation.
In some cases, your company may realize instant tax gratification by currently deducting the full cost of business property placed in service in 2022 — even if it occurs as late as December 31st.
Under Section 179 of the tax code, a business entity may “expense” the cost of qualified property placed in service, up to an annual limit. However, the deduction can’t exceed the amount of income from the business activity and is subject to a phaseout above a specified threshold.
The maximum deduction is an inflation-indexed $1 million, and the phaseout threshold is an inflation-indexed $2.5 million. For property placed in service in 2022, the numbers are $1.08 million and $2.7 million, respectively.
The 2023 maximum Section 179 deduction of $1.16 million provides plenty of leeway for many manufacturers, but two key limits could affect your purchasing decisions in 2023.
Annual Income Limit
The Section 179 deduction can’t exceed the net taxable income from the business’s activities. For example, if a manufacturer shows an $800,000 profit in 2023, the actual deduction is limited to $800,000, even if the property costs more.
Annual Dollar Threshold
If the total cost of property placed in service during the year exceeds an annual threshold, the maximum Section 179 deduction is reduced on a dollar-for-dollar basis.
This dollar threshold has been adjusted by the Tax Cuts and Jobs Act (TCJA) in conjunction with the maximum Section 179 allowance, plus inflation indexing. The 2023 threshold is $2.89 million. Be mindful of these limits as the end of the year approaches.
Typically, if you need equipment or machinery to keep your manufacturing business humming, you won’t have all the cash on hand to complete the purchase. Fear not. You can still write off the full amount of the cost — up to the applicable limits — if you finance the purchase.
For example, let’s say your company needs $1 million of new equipment to meet its obligations for 2023. You can afford only a $250,000 down payment so you borrow the remaining $750,000 under favorable terms from a lender. You expect the company to realize profits of $5 million in 2023, so the annual income limit isn’t a problem.
Based on these facts, you can deduct the entire $1 million under Section 179, even though you’re financing three-quarters of the overall cost. Be aware that finance charges paid on the loan are deductible as business interest subject to the usual rules.
Finally, keep in mind that the Section 179 deduction isn’t automatic. You must claim it on a property-by-property basis. In other words, you must claim each piece of equipment you place in service during the year. Contact us for more information.
This covers 100% of the cost of qualified new or used property. For these purposes, qualified property includes tangible property depreciable under the Modified Accelerated Cost Recovery System (MACRS) with a cost recovery period of 20 years or less. This type of property is often used by manufacturers.
With the combination of the Section 179 deduction and bonus depreciation, manufacturing companies may be able to write off the full cost of depreciable business property the first year the property is placed into service.
However, be aware that the first-year bonus depreciation deduction is scheduled to begin to be phased out in 2023, allowing deductions of:
After 2026, bonus depreciation will no longer be allowed unless Congress extends it. (For certain property with longer production periods, these reductions are delayed by one year.)
The MACRS is generally associated with “regular” depreciation deductions. With the MACRS, the cost of qualified property placed in service is recovered over a period of years. The system is designed to provide larger write-offs in the early years of ownership and smaller deductions thereafter.
The annual deductions are based on the useful life of the property. For example, there’s a five-year write-off period for computers, while most other equipment or machinery is depreciable over seven or fifteen years.
Generally, a manufacturer may supplement Section 179 and first-year bonus depreciation deductions with MACRS deductions for any remainder. But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the typically less favorable mid-quarter convention.
Vehicle purchases may be eligible for Section 179 expensing, and buying a large truck or SUV can maximize the deduction.
Keep in mind that additional rules and limitations apply to depreciation-related deductions. Consider all the tax ramifications of year-end purchases of business property for your manufacturing company.
The Inflation Reduction Act (IRA) became law on August 16, 2022. It includes considerable expansions of existing tax credits in manufacturing and other areas, and it establishes several new tax credits.
The credits offer incentives for the production and use of renewable energy. They include credits for clean energy production, sustainable building practices, and the use of electric vehicles (EVs).
Four tax credits in particular — including a new credit established by the IRA — should be of particular interest to manufacturing companies that produce equipment used in EVs and other “green” energy projects.
Section 13502 of the IRA creates a new tax credit known as the Advanced Manufacturing Production Credit (AMPC), which provides a tax credit for the manufacture and sale of “eligible components” starting in the tax year 2023.
A taxpayer must meet the following criteria to be eligible:
The statute’s definition of “eligible components” includes:
The IRA identifies specific amounts that taxpayers may claim for different components, expressing some credits as formulas.
The amount of the AMPC for most components will start to phase out in the tax year 2030. It will be 75% of the amounts shown in the statute that year. In 2031, it will be 50%, followed by 25% in 2032. It will not be available in 2033 or later.
The Production Tax Credit (PTC) provides a tax credit over a 10-year period to taxpayers who generate various types of renewable energy. The IRA reinstates some PTCs that had expired, expands or extends others, and creates new ones.
The amount of the credit is based on the number of kilowatt-hours (kWh) generated during the tax year, with annual adjustments for inflation.
The base value of the PTC for 2023 is $0.30 per kWh. The projects must begin construction before 2025 to be eligible for the credit.
Multiple sections of the IRA address PTCs. The law increases the rate for some PTCs by 10% if they meet “domestic content” requirements with regard to steel, iron, or manufactured products used for energy production.
Manufactured products meet the IRA’s requirement if at least 40% of their costs were spent in the U.S.
The Investment Tax Credit (ITC) provides a tax credit to offset the cost of installing clean energy production facilities.
It is similar in many ways to the PTC, but one important difference is that the ITC is available all at once, while the PTC is spread out over a 10-year period.
Many types of facilities may choose between the PTC or ITC, but they cannot claim both tax credits.
The amount of the ITC is 6% of the installation cost, or 30% if the facility meets any one of the following criteria:
A taxpayer can increase the amount of the credit by meeting the “domestic content” requirements previously discussed. An ITC of 30% would increase to 40% if the taxpayer meets those criteria.
Section 13401 of the IRA replaces the existing tax credit for electric vehicles with the Clean Vehicle Credit (CVC), found in IRC § 30D.
Taxpayers may receive a credit for every “new clean vehicle” they put into service during a tax year. The total amount of the credit can be as much as $7,500.
A credit of $3,750 is available if the vehicle’s battery includes “critical minerals.” This term refers to certain materials that were either:
The percentage of the battery that must consist of critical minerals will start at 40% and increase each year until it reaches 80% in 2027.
This section of the IRA uses the same definition of “critical mineral” used for the AMPC, found in IRC § 45X(c)(6). The list includes aluminum, chromium, graphite, lithium, nickel, tin, platinum, and zinc, among many others.
The second $3,750 credit is available when a specified percentage of the vehicle’s battery is manufactured or assembled in North America. The percentage starts at 50% and will increase annually, reaching 100% in 2029.
The CVC is not available for certain electric vehicles with critical minerals or battery components from a “foreign entity of concern.” This includes foreign governments and other organizations that have received adverse designations from the Secretary of State, Attorney General, Secretary of the Treasury, or Secretary of Energy.
The Definitive Guide to Business Tax Credits and Deductions
Nothing is certain but death and taxes. While this may apply to federal taxes, state taxes are a bit more uncertain.
Manufacturers operating in more than one state may be subject to taxation in multiple states. But with proper planning, you can potentially lower your company’s state tax liability.
The first question manufacturers should ask when it comes to facing taxation in another state is: Do we have nexus?
Essentially, this term indicates a business presence in a state that’s substantial enough to trigger that state’s tax rules and obligations.
Precisely what activates nexus depends on that state’s chosen criteria. Common triggers include:
Depending on state tax laws, nexus could also result from installing equipment, performing services, and providing training or warranty work in a state, either with your own workforce or by hiring others to perform the work on your behalf.
A minimal amount of business activity in a state probably won’t create tax liability there.
For example, an original equipment manufacturer (OEM) that makes two tech calls a year across state lines probably won’t be taxed in that state.
As with many tax issues, the totality of facts and circumstances will determine whether you have nexus in a state.
If your manufacturing company licenses intangibles or provides after-market services to customers, you may need to consider market-based sourcing to determine state tax liabilities.
Not all states have adopted this model, and states that have adopted it may have subtly different rules.
Here's how it generally works:
If the benefits of a service occur and will be used in another state, that state will tax the revenue gained from the service. “Service revenue” generally is defined as revenue from intangible assets — not the sales of tangible personal property.
Thus, in market-based sourcing states, the destination of a service is the relevant taxation factor rather than the state in which the income-producing activity is performed (also known as the “cost-of-performance” method).
Essentially, these states are looking to claim a percentage of any service revenue arising from residents (customers) within their borders.
But there’s a trade-off because market-based sourcing states sacrifice some in-state tax revenue because of lower apportionment figures. (Apportionment is a formula-based approach to allocating companies’ taxable revenue.)
But these states feel that, even with the loss of some in-state tax revenue, they’ll see a net gain as their pool of taxable sales increases.
If your manufacturing company is considering operating in another state, you’ll need to look at more than logistics and market viability.
A nexus study can provide insight into potential out-of-state taxes to which your business activities may expose you. Once all applicable income, sales and use, franchise, and property taxes are factored into your analysis, the effect on profits could be significant.
Bear in mind that the results of a nexus study may not be negative. If you operate primarily in a state with higher taxes, you may find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state by maybe setting up a small office there.
We can help you understand state tax issues and provide a clearer picture of the potential tax impact of your manufacturing business crossing state lines.
Inflation. Labor shortages. Supply chain delays. Manufacturers have had a lot on their plates the past couple of years.
Across the board, the result has been increasing prices. But raising prices without factoring in market-based considerations might not be enough.
Direct production costs are a logical starting point for pricing new and existing products.
For example, suppose Manufacturer A spends $4 in raw materials and $6 in labor to manufacture a widget. The business owner adds up these costs ($10) and applies a 10% markup to arrive at the selling price of $11 for each widget.
The problem is that markups are often based on historic performance or gut instinct.
What happens when Manufacturer B sells its widgets for $10? This often happens to smaller manufacturers that compete with larger companies that can negotiate lower supply costs or companies located in areas with lower labor rates.
Unless Manufacturer A can provide a compelling reason for customers to pay a premium, such as superior quality or more responsive customer service, its market share will likely diminish — and overhead costs will eventually consume profits.
Conversely, what if the $11 price point is significantly below competitors’ prices? Below-market pricing may cause demand to skyrocket — and the factory might not be able to produce enough widgets to keep up with demand.
As a result, quality may suffer, or customers may become frustrated by production delays.
When demand outpaces production capacity, cash flow shortages also may occur because of lags in the cash conversion cycle. That is, Manufacturer A will need to front production costs (cash outflows), but it will take a while to bill and collect payments from customers (cash inflows).
A slight price increase can help reduce demand and the pressure it’s putting on plant workers.
To be a market leader, you’ll need to factor more than direct costs into your pricing strategies. This means conducting market research, which improves the accuracy of your sales forecasts.
For example, salespeople can informally survey customers about which features they value most, how the company can improve the customer experience, and how much customers would be willing to pay for new products or improvements to existing products.
To entice customers to participate in these surveys, consider offering free trials of new products or discounts on future orders.
It’s also important to research competitors. Pay attention to the products they offer, the prices they charge, and how they position their products in the marketplace.
Any research aimed at competitors must be ethical and legal, however. For example, you shouldn’t hire a competitor’s R&D director and solicit proprietary information. But you can legitimately visit a competitor’s website and review copies of print marketing materials that are available to the general public.
Market research can help you position your company’s offerings relative to those of competitors — and determine whether future sales volume will be similar to past performance.
Forecasts are often based on historical sales volume. But changes in market conditions (such as the introduction of a new competitor, changes in technology, and evolving customer needs) may require adjustments to what worked in the past.
Manufacturers need to forecast and allocate overhead costs to products to help them make better-informed pricing decisions.
As with sales, future overhead costs may not mirror what you’ve paid in the past — especially in today’s inflationary, labor-constrained marketplace.
Materials and labor costs are just a few of the expenses manufacturers incur. Overhead items may be variable (such as sales commissions, packaging, and shipping costs) or fixed (such as depreciation on equipment, managerial salaries, and rent).
As a company grows, it may need to obtain a larger factory or additional salespeople, leading to incremental fixed costs.
Today’s economy necessitates product pricing based on more than just direct production costs, even if adjusted for spikes in the costs of raw materials or labor.
Contact us to review and implement pricing models based on personalized market research and comprehensive costs.
Before the pandemic, many manufacturers’ supply chain management efforts focused on reducing costs and increasing efficiency, in some cases at the expense of flexibility and resiliency.
But the pandemic highlighted the vulnerability of global supply chain disruptions caused not only by public health emergencies, but also by natural disasters, political unrest, economic volatility, and other risks.
To prepare for future disruptions, manufacturers should reexamine their supply chain approaches and consider the following three strategies.
A Plan for Every Part (PFEP) isn’t a new concept, but it’s taken on added significance post-pandemic.
A PFEP is a robust, end-to-end plan for all the parts that make up your products. Start with a detailed analysis of the demand for all parts:
This information allows you to measure the importance of each part to your manufacturing process. Then you can assess the risk associated with potential disruptions of that part’s supply chain and develop strategies to mitigate the risk.
For example, if a part is particularly critical, you might keep more of it in stock (despite the increased cost) to ensure you can meet customer expectations during a supply chain disruption.
Another approach to consider is vertical integration (that is, bringing production of the part in-house). This alternative gives you more control over the supply chain.
Just as investors reduce their risks by diversifying their portfolios, manufacturers can reduce their risks by diversifying their supply chains.
Develop a mix of suppliers of different sizes and in different geographical regions to mitigate the risk that the unavailability of one supplier will devastate your business.
If a natural disaster or other event forces a supplier to close its doors or temporarily suspend its operations, other suppliers will be available to pick up the slack and minimize disruptions to your manufacturing process.
In every supply chain, it’s critical to develop and maintain strong relationships with your suppliers, especially during challenging times.
Good communication with your suppliers will help you stay informed of developments that affect the availability of key supplies. Then, you can quickly take steps to respond to any shortages.
As you may be acutely aware, supply chain issues continue to be a major problem for a variety of industries — especially manufacturing.
Contact us for help in reviewing the strategies discussed. We can help your manufacturing business enhance its supply chain resiliency and improve your chances of weathering the next supply chain storm.
For most manufacturing businesses, workers’ compensation insurance is a significant expense. Here are five tips to better control these costs:
Workers’ compensation insurers assign risk classification codes to employees based on their duties, responsibilities, and level of exposure to the risk of injury or illness.
Higher risks mean higher premiums, so be sure employees are properly classified. If an employee who now works in the office (or from home) is still classified as a production-floor worker, your premiums may be needlessly inflated.
Used to calculate workers’ compensation insurance premiums, the experience modification rate — also known as the experience modifier — represents your company’s loss history relative to the industry average.
If you have an average loss history, your experience modifier will be 1.0. A higher-than-average loss history will raise your modifier above 1.0, increasing your premium. A lower-than-average loss history will have the opposite effect.
Find out how your insurer determines its modifier and verify that the calculations are accurate.
The most effective way to reduce workers’ compensation costs is to avoid accidents and injuries.
That’s why it’s critical to develop a solid safety program that follows the Occupational Safety and Health Administration’s (OSHA) industry standards.
Train new hires thoroughly on safety protocols and procedures, as well as on the proper use of any equipment they’ll be using. From there, provide ongoing training and education as much as possible.
Once your program is up and running, review and evaluate your safety performance regularly and update the program as necessary.
The strongest safety standards are effective only if they’re followed and enforced, so it’s essential to make safety a part of your company’s culture.
This means setting the tone at the top and communicating to employees the importance of not only following safety guidelines but also reporting accidents or injuries promptly.
If employees are hesitant to report injuries or feel pressure to “work through the pain,” your workers’ compensation claims may eventually balloon both in number and magnitude.
Building a safety culture involves sound hiring and training processes, too. By discussing your company’s expectations regarding safety during interviews, you can get a feel for an applicant’s proclivity for risky behavior.
Training should emphasize safety practices and stress the importance of prompt reporting of accidents and injuries.
As the amount of time injured workers are off the job increases, their claims for lost wages will also go up while the likelihood of their return diminishes. A formal return-to-work program can help you retain employees and control workers’ compensation claims.
These programs can help reintegrate injured workers into the workforce as soon as possible, typically in less physically demanding roles and often on a part-time basis.
If an employee earns less than his or her preinjury wages during this period, the workers’ compensation insurer may make up the difference. The result is that injured workers return to their regular duties more quickly, reducing the costs of claims and minimizing the impact on your premiums.
If you’re contemplating selling your manufacturing business, be sure you understand the tax implications.
The way your business (as well as the transaction) is structured can impact your tax bill and, therefore, your net proceeds from the sale. Here are some issues to consider.
If your business is a corporation (either an S corporation or a C corporation), deciding whether to structure the transaction as a stock sale or an asset sale may have a significant impact on its tax treatment.
Generally, a stock sale is preferable from the seller’s perspective. That’s because when shareholders sell their stock, the profits generally are taxed at favorable long-term capital gain rates — currently a top rate of 20%, compared to a current top rate of 37% on ordinary income.
In contrast, asset sales usually generate a combination of ordinary income and capital gains, depending on how the purchase price is allocated among the business’s various assets.
From the buyer’s perspective, on the other hand, an asset sale is usually the structure of choice. A buyer of stock generally inherits the corporation’s basis in its assets. If the corporation has already taken significant depreciation deductions on those assets, there may be little or no basis for the buyer to write off. But a buyer of assets generally receives a basis equal to the portion of the purchase price allocated to each asset, generating valuable tax write-offs.
The seller’s form of business is another important consideration. If the seller is a C corporation, for example, a potential drawback of an asset sale is double taxation.
First, the business pays corporate tax on any gains from the sale. Then the shareholders are subject to a second tax when the sale proceeds are distributed to them as dividends. (Note: It may be possible to defer the second tax by having the corporation hold and invest the sale proceeds.)
Double taxation isn’t an issue for stock sales. The buyer acquires the stock directly from the shareholders, so there’s no entity-level tax.
Double taxation usually isn’t a concern for S corporations. As pass-through entities, income is taxed directly to shareholders at their individual tax rates. So, there’s no entity-level tax, even if the transaction is structured as an asset sale.
There’s a possible exception for a business that had previously been taxed as a C corporation but later elected S corporation status. Depending on how much time has passed, asset appreciation during the business’s time as a C corporation may be subject to two levels of tax.
Partnerships (including limited liability companies taxed as partnerships) don’t have stock, but it’s possible for the owners to sell their partnership or LLC membership interests to a buyer. It’s important for the sellers to understand, however, that this isn’t the same as selling stock for tax purposes.
A sale of partnership or LLC interests is treated essentially as a sale of the underlying assets, typically resulting in a mix of ordinary income and capital gains to the sellers.
When a transaction is structured as an asset sale, the allocation of the purchase price among the various assets has significant tax implications for both buyer and seller. Often, the parties have conflicting interests, which can lead to intense negotiations on this issue.
Keep in mind that the parties’ allocation of the purchase price isn’t binding on the IRS, though the IRS generally will respect the parties’ agreement so long as it bears a reasonable relationship to asset values.
Sellers generally prefer to allocate as much of the purchase price as possible to goodwill and other intangible assets that generate lower-taxed long-term capital gains.
And they prefer to allocate as little as possible to equipment and other depreciable assets.
Because previous depreciation deductions taken on these assets are subject to “recapture” at ordinary income tax rates.
Buyers, on the other hand, prefer to allocate as much of the purchase price as possible to these assets because they can depreciate them quickly or, in some cases, claim 100% bonus depreciation in the first year.
To successfully negotiate the sale of your manufacturing business, it’s critical to understand all of the tax implications. Armed with this knowledge, you can assess the impact of various transaction structures and purchase price allocations on your net proceeds from the sale and potentially adjust the purchase price accordingly.
We can help guide you through the sale of your business.
Running a manufacturing or distribution business requires an understanding of the unique dynamics of the industry.
SVA has the industry-specific accounting expertise you need. We will help you maximize tax credits and streamline your financial reporting.