IS “MADE IN AMERICA” THE RIGHT MODEL FOR YOUR BUSINESS?
ANDREW DOMBRO, CPA
Customer preference for American-made products is not new. After strained supply chains due to the COVID-19 pandemic, the decision to move from overseas suppliers to domestic factories may have been made for you. But higher labor rates and overhead costs may cause some “homegrown” products to be more expensive than foreign-sourced products. Will your purchasers balk at the higher price tag?
As 2023 starts, manufacturers and distributors should weigh whether a Made-in-the-USA strategy will help attract customers. Here are some angles to consider to position your business accordingly.
Related Read: Making “Made in the USA” Work
What are the rules?
To claim a product is “Made in the USA,” you must comply with strict regulations enacted by the Federal Trade Commission (FTC). Under the rules, final assembly must take place on U.S. soil and the majority of total manufacturing costs must be spent on U.S. parts and processing. Complex labeling standards may also apply if an American flag or map is used on packaging to imply the country of origin.
However, a company can make a qualified claim when a product is made in several countries; for example, it may specify the percentage of a product’s domestic content or label a product as “Assembled in the USA” instead.
Compliance with these rules is essential when starting new advertising programs or repackaging with the “Made in the USA” label. False claims are likely to attract an FTC investigation, which could lead to enforcement actions and negative publicity. Violators also may need to modify packaging to comply with the FTC regulations, which can be another costly expenditure.
What are the benefits?
Deciding to have your product “Made in the USA” will undoubtedly benefit domestic manufacturing. Prepare by investing staff, inventory and equipment to meet increasing demand for domestic-made products. Remind your customers about the benefits of using domestic manufacturers. This includes:
Less Expensive and More Reliable Shipping. Tariffs and high shipping costs can make overseas production cost-prohibitive. And volatile foreign political environments may prevent products from shipping on time, leading to production delays.
Domestic Labor Force. People feel patriotic when they support the U.S. economy and create jobs for American workers. They also want to know that factory workers are not subjected to unsafe conditions, low wages or other forms of exploitation that the U.S. Department of Labor and domestic labor unions protect against.
Limiting Business Risks. Intellectual property theft and devaluation of the U.S. dollar are just some of the risks companies face when they outsource production to other countries. Additionally, important instructions — such as product specifications or shipping terms — may be lost in translation when communicating with foreign suppliers.
Product Safety. Contaminated plastic and pet food products have led to recalls, illnesses and even deaths. Products made under the scrutiny of the U.S. Food and Drug Administration and Departments of Commerce and Agriculture are typically held to higher quality standards than many foreign-made products. Safer materials and products give manufacturers peace of mind that they are not exposing end-users to unsafe products — and themselves to liability claims.
Environmental Effects. The U.S. Environmental Protection Agency also requires manufacturers to adhere to strict environmental standards that limit emissions and pollutants. Other countries, including China and India, are making huge carbon footprints today that will harm the environment for many years.
Is it time?
For manufacturers that have used overseas suppliers, deciding when and whether to return to U.S. factories and suppliers can be a tough decision. If you do make the move, consider implementing a marketing campaign that positions your products as American-made, whether you sell to businesses or consumers.
PLANNING AN EXIT STRATEGY FOR YOUR BUSINESS
MARK THOMSON, CPA
Tips to maximize value and minimize taxes
Every business owner should have an exit strategy that helps recoup the maximum amount for their investment. Understanding the tax implications of a business sale will help you plan for — and, in some cases, reduce — the impact on your tax bill. This article will focus on selling your business to a third party. Below are some considerations to help ensure the transition is as smooth as possible:
Related Read: Family Business: Choosing the Right Exit Strategy
Start by obtaining a professional valuation of your business to give you an idea of what the business is currently worth. The valuation process also will help you understand what factors drive the value of your business and identify any weaknesses that reduce its value.
Once you’ve received a valuation, you can make changes to enhance the business’s value and potentially increase the selling price. For example, if the valuator finds that the business relies too heavily on your management skills, bringing in new management talent may make the business more valuable to a prospective buyer.
A valuation can also reveal concentration risks. For instance, if a significant portion of your business is concentrated in a handful of customers or one geographical area, you could take steps to diversify your customer base.
Structuring the sale
Corporate sellers generally prefer selling stock rather than assets. That is because the profit on a stock sale is generally taxable at more favorable capital gains rates, while asset sales generate a combination of capital gains and ordinary income. For a manufacturer with large amounts of depreciated machinery and equipment, asset sales can generate significant ordinary income in the form of depreciation recapture (Note: The tax rate on recaptured depreciation of certain real estate is capped at 25%).
In addition, if your company is a C corporation, an asset sale can trigger double taxation: Once at the corporate level and a second time when the proceeds are distributed to shareholders as a dividend. In a stock sale, the buyer acquires the stock directly from the shareholders, so there is no corporate-level tax.
Buyers, on the other hand, almost always prefer to buy assets, especially for equipment-intensive businesses, such as manufacturers. Acquiring assets provides the buyer with a fresh tax basis in the assets for depreciation purposes and allows the buyer to avoid assuming the seller’s liabilities.
Allocating the purchase price
Given the significant advantages of buying assets, most buyers are reluctant to purchase stock. But even in an asset sale, there are strategies for a seller to employ to minimize the tax hit. One strategy is to negotiate a favorable allocation of the purchase price. Although tax rules require the purchase price allocation to be reasonable in light of the assets’ market values, the IRS will generally respect an allocation agreed on by unrelated parties.
As a seller, you will want to allocate as much of the price as possible to assets that generate capital gains, such as goodwill and certain other intangible assets. The buyer will prefer allocations to assets eligible for accelerated depreciation, such as machinery and equipment. However, depreciable assets are likely to generate ordinary income for the seller.
Allocating a portion of the purchase price to goodwill can be a good compromise between the parties’ conflicting interests. Sellers enjoy capital gains treatment while buyers can generally amortize goodwill over 15 years for tax purposes.
If your company is a C corporation, establishing that a portion of goodwill is attributable to personal goodwill — that is, goodwill associated with the reputations of the individual owners rather than the enterprise — can be particularly advantageous. That’s because payments for personal goodwill are made directly to the shareholders, avoiding double taxation.
You may need to take certain steps to transfer personal goodwill to the buyer. This may include executing an employment or consulting agreement that defines your responsibility for ensuring that the buyer enjoys the benefits of your ability to attract and retain customers. Buyers may want a noncompete agreement. These are common in private business sales and can help protect the buyer from competition from the seller after the deal closes.
Get started now
Different strategies can help you enhance your business’s value and minimize taxes, but they may take some time to put into place. Whatever your exit strategy, the earlier you start planning, the better.
Sidebar: Should you set up an ESOP?
An employee stock ownership plan (ESOP) might be a viable exit strategy if your business is organized as a corporation and you are not interested in leaving it to your family or selling to an outsider. An ESOP creates a market for your stock, allowing you to cash out of the business and transfer control to the next generation of owners gradually.
An ESOP is a qualified retirement plan that invests in the company’s stock. Benefits to business owners include the ability to:
- Begin cashing out while retaining control over the business for a time, and
- Defer capital gains taxes on the sale of C corporation stock to the ESOP if certain requirements are met.
ESOPs also provide significant tax benefits to the company, including tax deductions for contributions to the ESOP to cover stock purchases and (in the case of a leveraged ESOP) loan payments. S corporations may avoid taxes on income passed through to shares held by the ESOP.
But there are some downsides, too. For example, ESOPs are subject to many of the same rules and restrictions as 401(k) and other employer-sponsored plans. And they can involve significant administrative costs, including annual appraisals of the company’s stock. Contact your tax advisor to discuss if an ESOP is right for your manufacturing business.