For manufacturers, one of the hottest tax reform topics includes a reduction in the highest corporate tax rate, from 35% to 15%. Presumably, the new 15% rate would also be available to pass-through entities, such as partnerships and S corporations. However, in exchange for getting the reduced rate, owners of pass-through entities would be subject to a second level of tax on their distributions, similar to corporations. Also, there would be some type of anti-abuse mechanism in place, so that owners could not shift their compensation from the higher individual tax rates (35% under recent proposals) to profits taxed at 15%.
A change in the federal tax rate from 35% to 15% will likely have an impact to a company’s financial statements, once enacted. For example, if a company has gross deferred tax assets of $1,000,000,the carrying value of those deferred tax assets would be $350,000 (35% current rate times $1,000,000). However, if a 15% rate is enacted, that same $1,000,000 of deferred tax assets would then have a carrying value of only $150,000 (15% times $1,000,000). This would create a $200,000 ($350,000 minus $150,000) reduction in deferred tax assets for the company, and a corresponding $200,000 tax expense hit to the financial statements.
Other talk includes allowing manufacturers to write off capital investments immediately rather than depreciating in exchange for giving up interest expense deductions; elimination of the alternative minimum tax; simplifying individual tax rates into three tax brackets: 10, 25, and 35 percent (currently, the brackets are 10, 15, 25, 28, 33, 35, & 39.6 percent); and the elimination of the Estate Tax.
Currently, the U.S. tax regime is based on worldwide income. The president’s plan would move to a taxing system on a territorial basis, meaning a U.S. company would only pay tax on U.S. source income.
From an international perspective, the president has called for a one-time repatriation of profits for companies that have made investments overseas. Although the rate has yet to be determined, prior comments from the president have indicated the rate to potentially be around 10%. This also has potential financial statement impacts for companies that have asserted an indefinite investment criterion for their investments overseas for financial statement purposes.
Over the coming months, tax reform measures will become much clearer as bills pass through Congress. Stay tuned for future developments and visit CohnReznick’s Manufacturing and Distribution industry practice page for current issues impacting the industry.