Last week, President Obama threatened to veto an agreement between Senate Democrats and House Republicans on a collection of tax breaks known as “tax extenders.” The deal would have been a huge win for manufacturing, because it would have extended or made permanent a number of tax breaks that directly benefit manufacturers. Now, the likely result is a one-year extension for incentives that lapsed in 2013. As a result of this breakdown in negotiations, 2014 may be manufacturers’ last chance to qualify for these valuable tax benefits.
Among the provisions at stake are the research and development tax credit, of which the manufacturing sector is a major beneficiary, and Section 179, which allows a certain amount of capital assets to be expensed rather than depreciated. The research and development credit would have been made permanent, while section 179 and bonus depreciation would have been extended. Section 179 is especially valuable to small businesses investing in large equipment and machinery. Many smaller tax breaks benefiting manufacturers of specific products, including those related to energy production and efficiency, also would have been extended.
Another, less obvious reason for manufacturers to support the tax extenders deal is because it would have operated as an obstacle to broader tax reform. For years now, the idea of lowering the corporate tax rate by eliminating various tax expenditures has enjoyed bipartisan support. While tax reform of this sort may be good for businesses generally, it may not benefit manufacturers, whose tax benefits would likely expire as part of any revenue-neutral corporate rate reduction package. If corporate reform means reducing rates of depreciation as prominent proposals suggest, it could mean higher tax bills for many manufacturers, especially those whose processes are capital-intensive. By contrast, the reported tax extenders deal would have benefited nearly all manufacturers, especially those with high capital costs.
The impending Republican takeover of the Senate makes the President’s unusual veto threat even more interesting. When President Obama and Senate Majority Leader-elect Mitch McConnell were asked after the midterms about areas of potential agreement, both were quick to mention tax reform. Senator McConnell was especially enthusiastic about “burning the midnight oil” to pass legislation and made reference to divided governments of years past that worked together to craft major reforms. Senator McConnell seemed genuine about his desire to cooperate with the President on tax reform and trade agreements.
If corporate tax reform results from a compromise, manufacturers should advocate for at least an extension of the research and development tax credit, since it too enjoys wide bipartisan support. They should also be partial to the President’s plan for a lower corporate tax rate for domestic manufacturing, and they should insist on relief for small businesses by increasing the deduction for domestic production to make up for the greater difference between personal income tax rates and the much lower corporate tax rate that results from reform. A tax extenders deal like the one nearly agreed to would have benefited manufacturers tremendously, but a broader tax reform package could include international as well as corporate tax reform, injecting liquidity into U.S. capital markets while also introducing a lower corporate tax rate.
In the short-term, it appears that tax extenders are headed for only a one year extension covering 2014. The combination of expiring tax benefits and uncertainty going forward puts manufacturers in a tough position. Assuming a one year extension is passed, small businesses thinking of purchasing machinery in the near future should try to take advantage of Section 179 and bonus depreciation while they still can. Come 2015, the tax consequences may differ dramatically.
Christopher R. Anderson is a law graduate with Foley & Lardner LLP. He is a member of the firm’s Finance & Financial Institutions Practice.