Joseph Calvanico, National Director for Property Tax and Valuation Services, Crowe Horwath (March 2011)
As the economy continues to show encouraging signs of a long-term recovery, savvy manufacturers are continuing to evaluate how to reduce their operating costs. Government funds - in the form of tax exemptions, credits, and incentives - can deliver a substantial boost to an organization's bottom line and free up resources for other initiatives. While state and local governments offer a wide range of assistance, the environment is constantly evolving, presenting a complex, moving target for manufacturers that operate in multiple jurisdictions. Executives who understand the landscape, sources of funding, and available exemptions can capture the full benefit of government funding and gain a competitive advantage.
Reassessment in light of budget shortfalls - Nearly every state and municipality is facing record budget shortfalls, creating tension between the competing priorities of fiscal austerity and long-term growth. In Texas, for example, tax exemptions for businesses were responsible for nearly one third of its budget deficit in 2010. Similarly, local governments across the country lost a total of $235 billion from state property tax exemptions in the past year.
While sales tax revenues rebounded in the last half of 2010, the stimulus funds that have kept some jurisdictions afloat will run out this year. Despite the pro-business agenda of many elected officials, government leaders eventually might be forced to curtail the level of assistance they extend to businesses.
Given this climate, manufacturers would be well advised to devote resources in the short term to understanding where the opportunities lie and how to qualify for them.
Two Primary Sources of Funding
The funds that states make available to manufactures come primarily from two sources. The requirements and processes vary for each, and companies will need to pursue slightly different strategies to take full advantage of them.
Property tax - Manufacturers in all states must pay taxes on their real property, i.e., land, warehouses, factories, offices, and other buildings owned by the business. As with most capital-intensive businesses, real property taxes can make up as much as 25 percent of a company's total property tax burden. Furthermore, approximately 40 states levy taxes on business personal property, which consists of tangible and intangible goods such as manufacturing equipment, furniture, and other assets needed for business operations. Property tax rates for businesses are determined at the local level but remitted at the state level. Since most exemptions are taken in the context of filing corporate taxes, manufacturers should be especially aggressive in looking for savings opportunities when preparing their returns (generally from February to May).
Sales and use tax - In all, 45 states impose a sales tax. In most states, municipalities can add their own sales tax; however, all sales taxes typically are remitted directly to the state, which administers the funds. The combined state and local rates can range from 5 percent to more than 10 percent. During the past decade, states have continued to enact sales tax exemptions for the purchase of materials that are directly used to produce goods for resale. The sales tax is levied at the point of sale, so manufacturers can either qualify for a certificate of exemption or file for a sales tax refund on goods after purchase.
Three Categories of Exemptions
While every state has slightly different definitions for the business expenditures that qualify for exemptions, qualified expenditures can be segmented into three main categories - capital, operational, and growth and development.
Exemptions for capital investments - States provide companies with a range of exemptions on capital expenditures such as equipment, machinery, parts, and supplies used in the manufacturing process. To exempt purchases from sales tax, manufacturers often must issue an exemption certificate to their vendors for purchases of machinery and equipment. In addition, such purchases could qualify for property tax exemptions.
Beyond the core machinery that actually produces goods, other types of equipment also qualify for exemptions. As the public's awareness of environmental issues - and the manufacturing activities that harm the environment - has continued to rise, states have increased exemptions for investments in pollution-control equipment as well as machinery used to recycle waste. Property tax exemptions are also available for buildings, equipment, and land involved in converting waste into new products.
Since companies that invest in permanent new factories are less likely to relocate, a number of jurisdictions offer property tax exemptions for the construction of new industrial facilities. Industrial property tax abatements provide incentives for manufacturers to build new plants, expand existing ones, renovate aging facilities, or add new machinery and equipment.
States such as Indiana, Michigan, and Nebraska make these funds available through exemptions, an industrial facilities tax (IFT), or as part of tax increment financing (TIF). Manufacturers that are considering these types of investments should contact their state economic development department or local authorities early in the planning process to determine what resources are avail able to defray construction costs.
Exemptions for operational expenditures - Companies should recognize that spending for any direct inputs in the manufacturing process might qualify for sales tax exemptions. In general, states are seeking to avoid taxing manufacturers twice - once when they purchase the materials they need to produce goods for retail sale and again when the finished goods are sold. Three types of spending make up a substantial portion of a manufacturer's operational budget.
1. Resale and wholesale goods: In most states, purchases of tangible personal property are exempt from sales tax if the item becomes an integral part of the product being manufactured.
2. Packaging and containers: Materials that house the finished goods for transport and sale at a later date typically also are exempt from sales tax.
3. Energy: Many states provide sales tax exemptions on the use of electricity, coal, gas, fuel oil, or nuclear fuel directly used and consumed in the manufacturing process. In general, energy used in transporting goods or for other activities (such as sales) is subject to tax.
Growth and development incentives - The increased competition among jurisdictions for desirable companies has resulted in a number of credits and incentives for manufacturers looking to expand operations, hire staff, relocate, or invest in work force development. To gain access to these funds, executives should identify applicable incentives during their organization's strategic planning and work closely with state and local officials to negotiate the most favorable terms.
Challenges in Securing Government Funds
Work force expansion: In many states, manufacturers can qualify for credits or refunds on their withholding taxes by achieving specific targets for hiring and employee retention.
Relocation: Since the moving costs for relocating operations to another jurisdiction are substantial, some states offer cash grants to purchase new equipment or defray the cost of transportation.
Job training: Many states, in an effort to ensure the competitiveness of their work force, offer grants to companies for the training of current and new employees. For instance, Rhode Island offers a credit against the corporate income tax or the insurance premium tax equal to 50 percent of eligible training investments. Typically, employees must make a certain salary for training programs to qualify for reimbursement or tax credit.
Cost-effective financing: The economic development departments of many states offer loan guarantees to manufacturers looking to invest in or expand their operations. Companies can negotiate interest rates and amortization periods to support their strategic needs.
Once a manufacturer has become acquainted with the wide range of exemptions, it still faces several obstacles to qualifying for exemptions.
Monitoring evolving requirements across states
- Since each state is in the process of re-evaluating its exemptions to jump-start private investment, regulations differ markedly by state and municipality and are constantly shifting. In addition, the application processes from state to state can vary in duration and complexity. Michigan has a very lengthy application process, for example, while Georgia has reduced the number of steps to make it easier for businesses to qualify. Each additional jurisdiction in which a manufacturer operates compounds the resources needed to keep up with the latest developments.
- During the recession, many businesses were forced to cut staff dramatically, and the employees who remain often are stretched incredibly thin. Applying for exemptions requires an understanding of not only the state and local tax codes but also of operations and specific uses of equipment. An exemption for pollution-control equipment, for example, extends beyond devices such as thermal oxidizers to attendant equipment that is necessary for them to function. At one pharmaceutical company, executives didn't realize that a large amount of their equipment could qualify for a pollution-control exemption. When they applied the proper definitions to their operation, these expenditures accounted for 25 percent of their $2.5 million property tax bill.
Integrating incentives and exemptions into strategic planning
- Effective tax planning can have a dramatic impact on a company's bottom line. Similarly, while manufacturers can draw on many forms of government assistance through tax filings, others require some foresight and planning. A manufacturer considering a relocation or expansion, for instance, must secure credits and incentives before announcing its plans, since once its intent is publicized, states have little impetus to extend funds. Therefore, exemptions should be a regular component of an organization's annual strategic-planning sessions.
Steps to Qualify for Exemptions
Although securing exemptions requires a significant commitment of time and resources, the potential benefits are too large to ignore. Manufacturers that identify applicable statutes and exemptions, understand processes and requirements, determine their eligibility, and apply for exemptions in the proper jurisdiction can improve cash flow and have more flexibility to pursue ambitious growth initiatives.