After the Business Ledger’s most recent Newsmaker Forum for the manufacturing industries, we had the opportunity to interview panelist Hugh Elliott. Hugh Elliott is a Senior Manager of Dugan & Lopatka, CPAs in Wheaton and one of the area’s leading experts to manufacturers. Following is a summary of the advice he shared.

 

Can you give us an example of a common challenge manufacturing firms have with the IRS?

One of the most common challenges we see is in the area of compensation for business owners. The IRS is on the lookout for any unreasonable salaries that a closely-held company pays to its shareholder-employees. In fact, this has been one of the tax agency's favorite audit targets in recent years. The IRS gets especially upset if a salary is considered too low and can levy additional taxation and possibly penalties if they believe S-corporation shareholders are trying to avoid social security, payroll and other taxes by keeping owner salaries low and distributing company proceeds in the form of distributions. Unfortunately, there are no hard and fast guidelines you can use to establish salaries that will pass muster with the IRS. Agents take several factors into account, such as compensation levels at comparable manufacturing companies, the profitability of the company and the role the employee plays in the business.

When times are tough, the payroll taxes a business has been withholding from employee paychecks might seem like an easy source of temporary cash. Some business owners think they’ll just borrow some money to pay urgent expenses and put it back later.

But that is often a serious, costly mistake. If the money isn’t there when it’s due, there won't be any sympathy from the IRS. That money belongs to the employees and is meant to stay in a trust fund to pay income taxes, Social Security and Medicare. With the "Trust Fund Recovery Penalty," the government can fine the business owner personally for 100 percent of the amount due, plus interest. The IRS frequently pursues collection of unpaid trust fund taxes from officers, directors and stockholders of the business, but can also go after other people who are considered "responsible" parties who acted "willfully."

Can you share any of your “golden gems” for tax savings for our readers?

Sure. Here is one we use all the time with our clients. As a commercial property owner, you’re probably depreciating the building over 39 years. So every year, you get to deduct 1/39th of the property’s value (excluding land) from your taxes. That's a long time to wait to receive all the tax benefits. Fortunately, there may be a way to accelerate the deductions and reduce the current year's tax bill. By conducting a "cost segregation study," you can dramatically speed up the depreciation process. That's because certain items that are part of the building may qualify for faster write-offs. Depending on the property, a cost segregation study takes a percentage of the cost out of 39-year depreciation and puts it into five, seven or 15-year recovery periods. It's best to do a cost segregation study when a building is placed in service but there may be opportunities available to your company if the building is less than ten years old too. Be careful to get an engineering-based study. That is what the IRS is accepting.

Most of our readers have heard about the manufacturing deduction, but confusion exists. Can you shed some light on this deduction?

Simple, Section 199, the Manufacturing deduction, provides a deduction equal to nine percent of an eligible taxpayer’s income for income attributable to U.S. production activities. The nine percent is phased in over time starting at 3% deduction in tax years 2005 and 2006, 6% in tax years 2007, 2008 and 2009, and 9% in 2010 and later.. The manufacturing deduction is intended to preserve jobs and keep manufacturing operations in the United States. The deduction is effective for taxable years beginning after December 31, 2004. Special rules are included for individuals and pass-through entities such as partnerships, S Corporations and Limited Liability Corporations. The definition of manufacturing activities is so broadly defined that nearly all manufacturers meet some part of the definition. Naturally, Congress put in some limitations. It is limied to 9% of the lower of qualified production activities income or taxable income before the deduction. The deduction is also limited to 50% of taxpayer’s employee wages for the year. The deduction calculation can be quite complex, consult your tax advisor for help.