Maintaining your company’s operations and staffing is always top-of-mind in the aerospace sector.
Below is a list of provisions of laws that can be used to generate a one-time or reoccurring cash flow for your operation:
2021 Stimulus Opportunities Available Under the American Rescue Plan Act
The American Rescue Plan Act was signed into law on March 11, 2021.
As part of this bill, the US Department of the Treasury provided both:
- An extension of $15 billion to the Air Transportation Payroll Support Program (PSP) for air carriers and functions directly related to the air transportation of persons or property—for example catering functions, ground handling of aircrafts, and sanitization functions
- A new program, the Aviation Manufacturing PSP, for $3 billion in additional PSP funding for aviation manufacturing contractors where the funds must be used exclusively for compensation and benefits and to facilitate the retention, rehire, or recall of employees
What Are Eligibility Criteria for the Aviation Manufacturing Payroll Support Program (PSP)?
The Aviation Manufacturing PSP will be administered by the US Department of Transportation. The criteria defines aviation manufacturing as either:
- Maintenance, repair, and overhaul of aircraft, aircraft engines, components, or propellers
- Operations of processes related to the design, development, or provision of an aviation product or service by an air carrier or contractors including a part, component, or assembly
More information can be found here. Your organization’s Data Universal Numbering System (DUNS) number will be required; register as soon as possible if it hasn’t been obtained yet.
Who Can Apply for the Aviation Manufacturing PSP?
An employer who has:
- Involuntarily furloughed or laid off at least 10% of its workforce in 2020 compared to 2019
- Experienced at least a 15% decline in 2020 revenues compared to 2019
- Identified the eligible employee group and the total compensation level for the eligible employee group
What Are the Compensation Restrictions of the Aviation Manufacturing PSP?
The total payroll support grant covers up to 25% of the aviation manufacturer’s workforce as of April 1, 2020, and only contains employees with a total compensation level of $200,000 or less per year.
Total compensation level includes both the level of total base compensation and benefits being provided to an eligible employee.
What Are Employer Limitations of the Aviation Manufacturing PSP?
Limitations could be imposed for employers if either of the following is true:
- They were allowed the employee retention credit under the CARES Act for the calendar quarter that immediately preceded and ended before entering into the agreement.
- They’re currently expending financial assistance under the Paycheck Protection Program (PPP) established under Section 7202(c) as of the date an application was submitted.
The intention is to avoid overlap with other payroll support programs.
2020 Stimulus Opportunities Still Available Under the CARES Act
Net Operating Losses (NOLs)
The CARES Act restored the five-year net operating loss (NOL) carryback for losses arising in any taxable year beginning after 2017 and before 2021. Companies with a NOL in 2020 can immediately request a refund by filing IRS Form 1139 to apply the loss, carrying forward any amount that isn’t used.
The CARES Act also allows 100% offset of taxable income and suspends the 80% limitation previously in place.
If any ownership changes have occurred during the three years leading up to a loss year, the amount of loss that can be used may be limited. The rules are complex, so it’s best to consult your tax advisor.
Learn more details about NOL opportunities afforded by the CARES Act in our webcast.
Should You Carry NOLs Back or Forward?
The CARES Act allows a taxpayer to decide whether to carry NOLs back or forward; this election can be made for each separate tax year in 2018, 2019, and 2020.
Most companies will benefit from choosing to carry the loss back because the corporate tax rate was lowered from 35% to 21% in 2018 as part of tax reform. Instead of receiving $21 of benefit for every $100 of loss carried forward, a corporation could receive $35 with a carryback—a permanent difference.
Given this rate differential, there could be an opportunity to reduce your taxable income through favorable accounting methods. While accounting methods generally create timing differences that may be of less interest to some taxpayers, corporations in particular could obtain a significant cash-flow benefit and permanent difference due to the restoration of the loss carryback rules. For example, changes to treatment of depreciable property, including repairs and improvements, could create substantial cash savings.
While the decision to carry losses back to earlier years with higher income tax rates may seem straightforward, the interaction with other income tax provisions, and the impact on other tax attributes, could complicate the decision. Modeling will be necessary in many instances to fully understand the impacts and determine the amount of available refund.
Employee Retention Tax Credit (ERTC)
Introduced in the CARES Act, then expanded in the Consolidated Appropriation Act, 2021 and the American Rescue Plan Act, the employee retention tax credit (ERTC) is a refundable tax credit used to offset the employer’s employment and withholding taxes paid on IRS Form 941.
Who Qualifies for the ERTC?
Employers whose business experienced a full or partial suspension due to emergency orders from a government authority that limited commerce, travel, or group meetings may qualify.
A business can also qualify if it experienced a reduction in gross receipts for the current calendar quarter compared to the same calendar quarter in 2019—a 50% reduction between March 13, 2020, and December 31, 2020, and a 20% reduction between January 1, 2021, and December 31, 2021.
What Is a Qualified Small Employer?
Qualified small employers for 2020 are measured as having fewer than 100 full-time employees (FTE) in 2019. For 2021, they’re measured as having fewer than 500 FTE in 2019.
A qualified small employer for 2020 and 2021 is able to claim credits on all their employee wages, whereas larger employers are only able to claim a credit for employees who are being paid and not performing services.
In addition, qualified employers may claim the ERTC if they’ve received a PPP loan and experienced a qualified full or partial suspension of operations or a qualified reduction in gross receipts. However, qualified wages for the ERTC don’t include wages paid from forgiven PPP proceeds.
What Is the Available Credit for the ERTC?
Depending on the qualification period, the credit could equal:
- 50% of qualified wages per employee, per quarter, up to a total of $10,000 in wages per employee for all quarters in 2020
- 70% of qualified wages per employee, per quarter, up to a total of $10,000 in wages for each of qualifying quarter in 2021
This means an employer eligible for the ERTC in all four quarters could receive up to $28,000 in credits per employee in 2021.
Employers who didn’t claim the ERTC on their originally filed IRS Form 941 may retroactively claim the credits using the IRS Form 941-X. Qualified small employers may also file IRS Form 7200 for an advance of the credit during the current quarter prior to filing an original IRS Form 941.
See our prior alert on how employers may qualify and be eligible for the ERTC during qualified quarters between March 13, 2020, and December 31, 2021.
Aerospace Accounting Method Changes
There are common accounting methods that aerospace and defense companies should revisit to enhance planning opportunities and tax attributes.
Accrual to Cash
Accrual to cash is an accounting method change that can be an effective way to defer taxable income—especially in the aerospace industry where standard receivable terms are 90 days or more, including government contracts.
This method change recognizes revenue when actually or constructively received and deducting items of expense when paid. Many aerospace and defense companies with average gross receipts for the three-prior year of less than $26 million can qualify to use the cash method of accounting.
Treating Inventory as Nonincidental Materials and Supplies
Companies with average gross receipts of less than $26 million for the prior three years can treat the cost of inventory as nonincidental materials and supplies. The cost can be recovered by expensing it through cost of goods sold in the year either when the inventory is provided to the customer or the year when the company pays for the cost of the item, whichever is later.
Conversion costs such as direct labor and overhead costs aren’t considered nonincidental materials and supplies.
Tangible property regulations provide that materials and supplies may be deducted if they have one or all of the following components:
- Acquired to maintain, repair, or improve
- Consist of fuel, lubricants, and similar items that will be consumed in 12 months or less
- Contain a unit of property with a useful life of less than 12 months
- Include a unit of property that costs $200 or less
- Can be identified in guidance as materials and supplies
Incidental materials and supplies—other than rotatable and temporary spare parts—can be deducted when paid. The change of method to begin deducting materials and supplies is automatic.
Rotable and Temporary Spare Parts
The tangible property regulations issued in 2014 provide three choices to account for rotable and temporary spare parts (R&TSP)—a common scenario in the aerospace sector.
Generally, R&TSPs are deductible in the tax year if the part is disposed of by the taxpayer during that year. Disposals can sometimes take several years and require capitalizing and tracking of these assets.
A taxpayer may elect to treat R&TSPs as a depreciable asset beginning in the year the part is placed into service. This election is irrevocable and can be made annually for each R&TSP and isn’t considered a method of accounting.
Tracking and Recordkeeping
The third and most complicated option for tracking R&TSPs is the method under Treasury Regulation 1.162-3(e). This method has several requirements that include maintaining detailed records, valuations, and accounting for R&TSP, which can make it undesirable to many taxpayers.
However, taxpayers who are able to track the use of R&TSP may realize the most accelerated deductions because it allows them to deduct the parts when first installed.
Deduction of Subnormal Goods
A company could be afforded a tax deduction for the write-down of subnormal goods if careful steps are followed. While many companies record an inventory obsolescence reserve on their financial statements, these reserves aren’t typically deductible for tax until realized.
If certain steps are taken, a deduction for subnormal goods is permitted for income tax purposes. The lower inventory valuation must be substantiated by providing evidence of the following:
- Actual offerings
- Actual sales
- Actual contract cancellations
Changes to Tax Inventory Capitalization Rules
The IRS issued final regulations in late 2018 for companies that maintain inventory. The tax inventory capitalization rules changed how companies use either the simplified production method (SPM) or simplified resale method (SRM). They also added a new method, the modified simplified production method (MSPM), that should be considered for larger producers.
Most importantly, the regulations don’t change the types of costs subject to capitalization or the amounts of these costs. Rather, they affect whether these types and amounts are included in the numerator, additional Internal Revenue Code (IRC) Section 263A costs, or denominator, IRC Section 471 costs, of the absorption ratio.
Companies will want to consider conforming to the new rules, and whether there’s an opportunity to reduce capitalization costs.
Timing of Revenue Recognition—IRC 451 and ASC 606
In December 2020, the IRS released final regulations for the timing of revenue recognition in the form of IRC Section 451 and Accounting Standards Codification (ASC) Topic 606. The final regulations provide an optional cost offset and an exception to recognition when there’s no enforceable right to payment.
The regulations refer to the applicable financial statement (AFS) income inclusion rule. It’s not a true book conformity requirement, but serves to accelerate, and not defer, taxable income. This could present a significant cash flow challenge for aerospace companies when the taxable income will trigger an accelerated recognition of income from ASC Topic 606. However, shifting revenue recognition to a book percentage-of-completion method (PCM) approach means the taxpayer won’t be allowed to offset with a corresponding acceleration of related expenses.
The final regulations allow companies opportunities to better match the related expenses to the accelerated revenue by permitting a reduction of revenue for the cost of goods incurred.
Considerations for the final regulations include:
- Realization. The final regulations don’t impact the determination of whether income is realized under IRC Section 61.
- Enforceable right. The final regulations provide that the AFS income inclusion amount doesn’t include amounts for which there’s no enforceable right to payment if the contract was terminated by the customer.
- Cost offset. The final regulations allow for the AFS cost offset method so a company can reduce the amount of income otherwise required under the AFS income inclusion rule.
If your company plans to adopt or has previously adopted ASC Topic 606, you’ll need to consider how the IRC Section 451 changes, as well as the related final regulations, impact your tax reporting.
Taxpayers who aren’t currently adopting ASC Topic 606 will still need to address the IRC Section 451 changes. You may be required to file one or more accounting method changes and have new book-tax differences to track.
For a detailed look at the effects of ASC Topic 606, please read our Revenue Recognition Guide and learn more adoption tips.
Long-Standing Tax Opportunities for Aerospace and Defense
Most aerospace and defense companies have qualifying activities for R&D credits. Typically, the tax savings is 7% to 12% of the qualified expenses.
In addition to the federal R&D credit, R&D tax credits are also available in approximately 40 states to offset state tax liability.
Prior to late 2020, it was believed the IRS held a position that expenses paid using forgiven PPP loan proceeds weren’t deductible for tax purposes. This led many to question whether nondeductible expenses could be included in their R&D credit. Guidance issued by the IRS in Notice 2020-32 and Revenue Rule 2020-27 regarding nondeductibility prompted concerns those same expenses would be ineligible for the R&D tax credit.
Clarification was provided in the Consolidated Appropriations Act, 2021 that no deduction or tax attribute shall be reduced. This resolved any concerns that qualified research expenses paid with forgiven PPP loans would be ineligible for the R&D tax credit. Accordingly, PPP loan forgiveness has no direct impact on qualified research expenses included in the R&D tax credit.
Start-up companies with less than $5 million in revenue can elect to use the credit to offset payroll taxes in lieu of income taxes. This gives companies that aren’t yet taxable for income tax purposes a way to monetize the R&D credit. Many companies in the space-tech subsector could be eligible to make this election.
On a less positive note, beginning for the 2022 tax year, companies will be required to capitalize and amortize their R&D costs for tax purposes. The amortization period will be five years for domestic research. For many companies, this tax treatment will differ from their treatment of these costs for generally accepted accounting principles (GAAP) purposes, resulting in a book-to-tax adjustment.
To learn more, please see 4 Things to Know about R&D Tax Credits for the Aerospace Industry.
Cost Segregation Study
Cost segregation is a tax deferral strategy that frontloads depreciation deductions into the early years of asset ownership by segregating cost components of a building into the proper asset classifications and recovery periods for federal and state income tax purposes.
The end result is significantly shorter tax lives—five-year, seven-year, and 15-year depreciation periods—rather than the standard 39-year depreciation period. Typically, cost segregation studies on A&D facilities can result in 25%–50% reclassification into shorter-life property.
The following may qualify for accelerated deductions:
- Facilities that have been acquired or constructed in the past 20 years
- Leasehold improvement projects to existing facilities
In addition to current-year projects, cost segregation can also be applied to project assets placed in service in prior tax periods without the need to amend any federal tax returns.
Qualified Investment Property (QIP)
As a result of the CARES Act, qualified improvement property (QIP) was retroactively changed to 15-year property dating back to December 31, 2017. Many property owners don’t take advantage of these provisions and end up paying federal and state income taxes sooner than necessary.
For example, let’s say an aerospace and defense company spends $15 million for a leasehold improvement project to an existing building. A cost segregation study identifies and segregates 30% of the costs as seven-year and 15-year properties that are eligible for accelerated depreciation—including bonus depreciation. In the first year, the company could recognize more than $4.5 million of depreciation—30% of $15 million—rather than ratably depreciating the entire project asset over 39 years.
State and Local Taxes
State and local taxes are varied and constantly in flux. Keeping abreast of them is a major challenge; yet failing to do so can significantly affect your cash flow and ability to compete.
This section contains information specific to California state tax.
Sales and Use Tax Refund Review
With more than 9,000 state, local, and district-level jurisdictions imposing sales and use taxes, combined with varying tax laws among the states, companies often overlook opportunities for savings that can affect their bottom line. A sales and use tax refund review can help your business identify these missed opportunities by securing sales tax refunds and avoiding overpayments in the future.
The objective is to secure overpaid sales and use tax refund by reviewing a company’s purchase-related information—such as fixed assets and accounts payable data along with related invoices—for the last three-to-four years.
The following manufacturing exemptions are typical opportunities for savings:
- Manufacturing equipment directly used in the manufacturing or processing
- Repair and replacement parts
- R&D equipment and parts
- Items purchased for resale
- Wrapping and packaging materials purchased for resale
- Federal and state government purchase-related exemptions
- Nontaxable services
- Other industry and state specific exemptions
The Colorado Aviation Development Zone Tax Credit is available to businesses located inside an aviation development zone airport that do aircraft manufacturing, maintenance, repair, completion, or modification.
The income tax credit is equal to $1,200 per new employee.
The Texas Enterprise Fund provides cash grants to companies that open or expand a facility within Texas when there’s at least one out-of-state option.
Cash grant amounts are discretionary and issued based on projected job creation and capital investment.
This section contains information specific to Washington state tax.
Leveraging Washington Business and Occupation (B&O) Tax
Given the 40% increase in the B&O tax rate for commercial aerospace manufacturers that occurred in 2020, commercial aerospace manufacturers should evaluate whether they’re fully benefiting from other aerospace incentive programs available to them—including the two below.
Property and Leasehold Excise Tax Credit
The real property tax credit is applied against B&O taxes paid and is equal to county property taxes paid on land and buildings used solely for commercial aerospace related manufacturing.
The personal property tax credit is equal to county property taxes paid on qualifying machinery and equipment used in commercial aerospace manufacturing activities.
Qualified Aerospace Product Development Expenditures Credit
The product development credit is applied against B&O taxes and is equal to 1.5% of qualified aerospace research expenditures, including:
- Employee benefits
If aerospace incentives haven’t been claimed, taxpayers can generally seek a refund of overpaid Washington taxes for the four preceding calendar years plus the current tax period—provided the annual incentive survey and report have been timely filed each year.
Washington Department of Revenue Business Relief During COVID-19
Washington state provides a tax exemption for B&O tax, public utilities tax, and retail sales tax for qualifying grants received from certain federal and state government programs related to national and state emergencies, including COVID-19, effective February 19, 2021. The tax exemption applies to qualifying amounts received on or after February 29, 2020.
For more details on how you can stay up to date on state legislation and pandemic relief, please see our state and local tax planning resources.
We’re Here to Help
If you have any questions about how to increase cash flow for your business, please contact your Moss Adams professional.