What is a manufacturer? Consult an accountant who’s studied the new American Jobs Creation Act, and he or she will tell you the Internal Revenue Service’s definition extends far beyond companies that assemble tractors, mold plastics or make high-tech equipment.

One of the most significant provisions for small- to medium-sized companies in the act, which President Bush signed into law on Oct. 22, provides a 3 percent tax break to be phased in over the next six years. The reduction, which applies to products made for the domestic market rather than export, includes not only traditional manufacturers, but also extends to construction companies, architectural and engineering firms, film and video production companies, software developers, energy producers and agricultural processors.

The primary purpose of the act — which lawmakers say balances $145 billion in tax breaks with an equal amount of new revenues by closing loopholes — was to phase out a federal subsidy provided to U.S. exporters on “extraterritorial income” that the World Trade Organization had ruled was illegal. However, it also provides a smorgasbord of new tax breaks that Greater Des Moines companies may want to take advantage of this tax year. The Business Record spoke with Tony Wagner, tax manager for Clifton Gunderson LLP in West Des Des Moines, about the law’s impact.

Q: With all the tax breaks that have been passed in recent years, what’s the difference between this law and earlier measures?

A: The American Jobs Creation Act has a lot of new changes in it, whereas the Working Families Tax Relief Act (which Bush signed into law in Des Moines on Oct. 4) did not necessarily have a lot of changes. Originally in 2001, Congress passed the Economic Growth and Tax Relief Reconcilation Act, which called for a phase-in of many tax breaks. Then in 2003, the Jobs and Growth Tax Relief Reconciliation Act was passed to accelerate some of those changes to 2003 and 2004, rather than 2005. So really, the (Working Families Act) essentially just made those changes occur now instead of having them go back to the automatic increases that would have been there had it not passed.



Q: Is the manufacturers’ tax break the biggest benefit of the act?

A: Yes, once it’s fully phased in in 2010, the companies that take advantage of this will have a tax rate on domestic manufacturing income that’s approximately 3 percent lower than other companies. The effect of the deduction is that their tax rate could go from 35 percent to approximately 32 percent.

Q: Will it be worth the time and effort for smaller companies to pursue the deduction?

A: It’s always a possibility (that it’s not worth it). But for the most part, once you have it set up and have the process in place, it’s a reduction that will be there for the next six years, and take minimal maintenance to keep it in place.

Q: The act allows individual taxpayers to deduct what they paid in state sales tax as an alternative to deducting state income tax. Will most Iowa taxpayers want to choose the sales tax deduction?

A: At this point, it’s hard to say. Most people don’t have their records back from Jan. 1 to keep track of this. The IRS is supposed to issue some average tables; whether they’re going to get that done before the end of the year is up in the air. It’s mostly going to impact (the nine) states that don’t have state income taxes. It’s always possible that someone’s paid a lot in sales tax but hasn’t paid a lot in income taxes.



Q: With some favorable modifications to the rules for setting up a business as an S corporation, should more companies now consider it?

A: We’ve always stressed that companies should at least look at it and see if it does make sense for them. The new rules don’t necessarily make it more advantageous to be an S corporation; they make it easier. The number of shareholders allowed has been increased from 75 to 100. And now, up to six generations of a family can be considered one shareholder. For smaller businesses, probably more than 50 percent are either S corporations or some type of partnership. Roughly 75 percent of new corporations that we see are being formed as S corporations.

Q: Do you think many businesses will get stung by the closing of some $67 billion in expensing loopholes, which Congress put in the law to make it revenue-neutral?

A: Some of them may be. Most of the clients we deal with are not in those types of transactions to begin with. It seems to be the larger individuals and corporations that are in those. The small to mid-sized companies seem to avoid them.

Q: How much political risk do the experts say there will be that some of these tax breaks that are being extended may go away if there are shifts of power in Congress or the White House?

A: With this manufacturers’ credit, as we understand it, that’s not going to be much of an issue because it’s something that both sides are pushing with the issue of the exportation of jobs to foreign countries. It gives companies an incentive to produce jobs and get that income back here, which is something both sides have said they’re in support of.

Q: What other changes will be important for companies to consider?

A: The changes to the deferred compensation rules are significant. A lot of our clients have some kind of deferred compensation arrangements set up; the rules for that have really been changed with this act. That’s something that we’re definitely going to talk to our people about. One of the biggest changes is that the deferral election must be made before the services are performed, and the method of how (the compensation) will be received must also be made beforehand about how you’re going to receive it in 20, 30 or 40 years. And some of the rules that allowed you to accelerate those distributions have also been tightened up. In the worst-case scenario, it’s possible that if an individual deferred $1 million today and didn’t follow the rules, in 20 years he would lose it all to taxes and penalties.