Batten the Hatches

In times of uncertainty in the manufacturing industry, it’s natural to huddle up and think through strategies that protect the short-term while preparing for the long game. Companies will often turn to their advisors between waves of growth to review their operations and make sure they are taking every precaution and advantage.

There is always plenty to talk about in manufacturing. As stated in a previous article, the disruption of oil and gas and energy consumption has impacted companies in the region in direct revenue, but also in their relationships with related industries that rely on the oil and gas industry.

Some of the strategies we’ve seen manufacturers employ have included adjustments to work shifts and right-sizing. However, they are also looking at ways to reduce inventory, improve processes, look for tax breaks and even step up estate planning and succession. The following are areas of the manufacturing business that owners and management can review for savings and efficiency.

Tax Incentives/Deductions

Smaller manufacturers don’t always perceive a qualification for the politically popular R&D credit. They should take another look. Some companies have discovered areas defined as R&D under the tax law that fit them perfectly even if they don’t consider themselves innovative. For example, an improved or proprietary process can qualify even if you don’t have an on-site lab or clean room. Also, think about that customer who asked you to make a small adjustment to the machining of a part. If you engineered it, it may qualify as R&D.

When companies are busy, owners or management aren’t always aware of qualifying innovation happening on the production floor. Consult with your CPA to bring those opportunities to light so they are communicated to staff and recorded regularly.

Other tax reduction strategies can be found in how manufacturers handle personal property taxes. Old assets should be removed from the books when new assets are purchased. Some assets may be improperly classified, resulting in overpayment. Many types of “equipment” can be exempt. In addition, certain idle equipment due to lack of demand may also be factored to reduce the personal property tax.

Of course, bonus depreciation is another go-to tax provision. Manufacturers may qualify under fixed asset expensing or through the Domestic Production Activities Deduction (DPAD). This allows for an additional 9 percent deduction of the lesser of taxable income, or 9 percent of “qualified production activities income” (QPAI). QPAI is equal to the amount by which gross receipts from eligible manufacturing and production activities exceed related expenses.

Activities include, but are not limited to:

• Manufacturing, production, growth or extraction of tangible personal property in the U.S.
• Construction of real property in the U.S.
• Performance of engineering or architectural services in the U.S. in connection with real property construction projects in the U.S.

A manufacturer may also qualify for additional tax rate reduction benefits under the interest-charge domestic international sales corporation (IC-DISC). This tax rate reduction is generated by creating a separate entity organized as a C-Corporation. The C-Corp is deemed to participate in the exporting process of the operating entity and earns a “commission.” That commission is paid by the operating entity, and it is an ordinary deduction, reducing ordinary income. Qualification for this type of tax reduction requires exploration of a manufacturer’s operation and sales chain as well as planning to set up the entity.

There are many other areas that manufacturers can explore with their CPA to improve their tax position.

Process Improvements for Manufacturing Operations

Manufacturers can look at various ways to improve efficiencies and reduce waste in the production line as well as save on utilities, maintenance and materials. In addition to integrated components and sensors to alert staff to potential breakdown, the design of production floors can improve workflow and move product out the door faster.

Manufacturers are also looking at simplifying the steps in each manufacturing process to speed production and make training and improvements easier later. Again, some of these may qualify for R&D, depending on the complexity of the changes and their impact on a particular product or the industry itself.

A lean process study and revamping of core processes could provide a double benefit of both improved profitability and production qualifications for the R&D credit.

Labor and Benefits

Texas-based manufacturers may experience more frequent inquiries by state and federal authorities regarding citizenship and fair labor practices.

Immigration and Customer Enforcement (ICE) will look at companies with a large workforce and ask for I-9s or proof of U.S. citizenship. If they find violations, they will give the owners a time period to comply or face fines. These inquiries and fines cause a disruption in business and unexpected costs. Manufacturers need to take a careful look at their employment rolls to avoid this turbulence.

The same can be said for trends in class action suits that target large groups of employees to pursue claims for unpaid overtime or unfair labor practices as outlined in the Fair Labor Standards Act. Employers, for example, that incentivize employees with bonuses based on production must also demonstrate compliance with any overtime owed to meet those production goals.

Manufacturers can receive incentives for hiring veterans or other special worker classes, but they must be careful when hiring these workers if reductions in force are required later. They don’t want to be perceived as manipulating the system, keeping employees only until requirements are satisfied.

On the benefits side, some larger manufacturers are setting up captive entities to self-insure the operation and/or employees — essentially paying premiums to their captive entity rather than to a third-party payer. If income is steady at $5 million to $6 million a year, a captive can provide another tool for owners as they plan for succession and retirement.

If you have any questions about how to add operational efficiencies, reduce taxes or plan for transfer of ownership in your manufacturing operation this year, talk to the manufacturing team at Cornwell Jackson.

Gary Jackson, CPA, is the lead tax partner in the Cornwell Jackson’s business succession practice. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services to management teams and business leaders across North Texas.

In the past year, manufacturing employment in the Dallas/Fort Worth area has dropped by 2 percent. This statistic alone seems negative, but the overall outlook for manufacturing is trending positive with increased focus on innovation, simplified supply chains, diversification into customer-focused services and creativity with materials performance and fuel sourcing. It’s still a challenging industry, but this real or perceived lull in growth is the perfect time to assess the structure and vision of your company. Strengthen the basics to be ready for what’s next.

Oil drives Texas. It’s no surprise that the manufacturers we talk to are concerned
about the drop in oil and gas prices. Many of them are tied to the industry as suppliers, fabricators and general contractors. Still, other manufacturers that are dependent on freight and shipping costs are more than happy to see fuel prices drop.

Then we have the valuation of the dollar against foreign currencies that affects trade. Manufacturers trying to compete against materials and products shipped cheaply from other countries must look for efficiencies besides price reduction. China’s economic slowdown does not seem to have helped the cause of U.S. based manufacturing, with weak performance reported around the world.

Although the Dallas/Fort Worth area outpaced many other states in overall economic growth in 2015, rather flat manufacturing performance did not help the cause. This fact was predictably offset by positive gains in hospitality, business and professional services, utilities and transportation, according to an economic update by the Federal Reserve Bank of Dallas.

Flat growth is not the final word. A pause in business is sometimes the perfect opportunity to review the vision, business model, processes and procedures, technology and other foundational contributors to growth. Let’s take a look at the current state of manufacturing and what manufacturers should focus on this year to prepare for the next wave of growth. If you clean house now and invest in the foundation of your business, you will be in a better position to seize opportunities when growth resumes.

Manufacturing Now

Manufacturing in developing countries continues to provide a path to rising incomes and living standards. In advanced economies, it is a source of innovation and competitive strength for exports and productivity. When the Recession hit the industry hard, employment fell with it, delaying the demand for skilled labor.

Well, the demand for labor isn’t necessarily back to the fever pitch of pre-Recession times simply because manufacturers have looked for ways to offset labor with equipment and automation. Manufacturers that have invested in automation since 2010 have survived and even thrived. They are crediting the investment — along with the trend in the Internet of Things (IoT) — to help them efficiently monitor inventory and productivity. Automation has also helped them anticipate and head off problems on the line or in the supply chain — reducing outages and downtime.

In fact, U.S. manufacturers may spend more than $5 billion on new robotic orders by the end of 2016, according to the Freedonia Group. In turn, the demand for labor has shifted to the types of employees who are skilled at both hardware and software. Manufacturers investing in IoT units to reduce maintenance costs and risk of outages will be ahead of their competitors as that industry ramps up in the next five years.

A strong base of defense and aerospace firms in Texas does support this move to what some are calling “advanced manufacturing.” Leaders are calling for the state to continue to create policies and make investments in higher education to support advanced manufacturing infrastructure.

An article in the December 2015 Dallas Business Journal also noted that Dialexa, a consulting firm for technology start-ups, planned to expand its hardware lab, which includes the company’s electrical engineering, embedded software, mechanical design, 3D printing and electrical assembly research and development. This is one example of a company working in emerging technologies that will incubate new types of manufacturing in the Dallas/Fort Worth region.

Manufacturing At Your Service

Another interesting shift in the industry is the expansion of services offered by manufacturers. Rather than strict product manufacturing, some industries employ half of their workforce in non-production roles. This includes R&D engineers, logistics staff and after-sales support and maintenance services. A report from the McKinsey Global Institute predicts that the role of manufacturing in advanced economies leans toward innovation, productivity and trade more than growth and employment. These advanced manufacturers also consume and provide more services than manufacturing facilities in developing countries.

A survey by Grant Thornton on technology trends found that the majority of more than 300 manufacturers surveyed in the U.S. believed that new technologies would bring new opportunities. The top five technologies cited were: robotics, advanced materials, IoT (sensors, interconnected machinery), 3D printing and big data (analytics).

The use of real-time data and analytics, for example, allows manufacturers to run more “what if” testing, according to the report. It can reduce risk and materials costs while improving quality and accelerating new product development.

What is holding back many manufacturers from taking the leap into all of these new technologies?  The biggest reason cited in the Grant Thornton report was economic uncertainty, followed by the perceived risks of adopting technology that isn’t completely proven.

Manufacturers are entrepreneurial, but when it comes to capital outlay they’ve learned to be cautious. Still, a move toward diversification seems to be a natural evolution. Manufacturing can now encompass proprietary customer designs, production and implementation and also after-care services. This diversification is already paying dividends for the job shops whose saavy owners realized the potential for value-added services. More services per customer leads to more loyalty and profit.

If you have any questions about how to add operational efficiencies, reduce taxes or plan for transfer of ownership in your manufacturing operation this year, talk to the manufacturing team at Cornwell Jackson.

Gary Jackson, CPA, is the lead tax partner in the Cornwell Jackson’s business succession practice. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services to management teams and business leaders across North Texas.