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In recent years, manufacturers have faced significant tax challenges, including mandatory R&D capitalization that increased taxable income, reduced equipment write-offs due to bonus depreciation phase-downs, and evolving state incentives. As a result, many missed out on valuable tax benefits. This landscape has now changed significantly.
The One Big Beautiful Bill Act (OBBBA), signed into law last year, revised several key provisions affecting domestic manufacturers. With strong state and local incentives and robust production-based credits, U.S. manufacturers now have access to a comprehensive tax planning toolkit. The primary challenge is understanding how to use these opportunities effectively.
Here’s what domestic manufacturers need to know to take full advantage of these tax-saving opportunities.
The Section 174 Saga Is Over, and the Recovery Window Is Open
Beginning in 2022, the Tax Cuts and Jobs Act required manufacturers to capitalize all research and experimental (R&E) expenditures rather than deduct them immediately. Domestic costs were amortized over five years, and foreign research costs over fifteen. For example, a company investing $2 million annually in process engineering and product development could see taxable income increase by $1.8 million in the first year, not due to higher profits but because of deferred tax treatment. This change significantly impacted cash flow, hiring, capital investment, and competitiveness for three tax years.
The OBBBA fixed it. Under the new Section 174A, enterprises can once again deduct domestic R&E expenditures in the year they are paid or incurred, effective for tax years beginning after December 31, 2024. The mandatory five-year amortization period for domestic research costs has been eliminated. Capitalization is now an election, not a requirement — and most manufacturers will have no reason to elect it.
While these changes apply going forward, the retrospective provisions are equally important.
For unamortized domestic R&E costs from 2022, 2023, and 2024, the OBBBA provides two recovery options: deduct all remaining unamortized costs in 2025, or spread the deduction across 2025 and 2026. This flexibility allows you to align deductions with years of higher taxable income, which is especially beneficial if 2025 is a strong revenue year.
Smaller manufacturers with average gross receipts below $31 million for 2022 through 2024 may elect retroactive treatment under Section 174A. This involves amending all affected returns for those years as if the capitalization requirement did not apply. While all years must be amended together, the potential refunds can be significant for businesses that incurred substantial tax liabilities during that period.
Two important caveats: Foreign R&E expenditures still must be capitalized and amortized over 15 years, regardless of your business size. And the IRS has updated Form 6765 — the R&D credit form — with stricter recordkeeping requirements that take full effect for the 2025 tax year. Boilerplate project descriptions and retroactive estimates won’t hold up anymore. If you’re claiming the R&D credit alongside the Section 174A deduction (and coordination between those two provisions calls for careful attention), your documentation needs to be contemporaneous, component-level, and specific about wages, activities, and business purpose.
If you have been depreciating R&D costs since 2022 and have not yet consulted your tax advisor, it is important to act promptly. The accounting method changes under Section 174A involve specific procedures and deadlines and require careful attention.
Section 179 and Bonus Depreciation: The Equipment Story Gets Better
Manufacturers often invest substantially in machinery, production equipment, computer systems, and facility improvements. The OBBBA has significantly enhanced the tax treatment for these investments.
Section 179 now permits an immediate deduction of up to $2.5 million for qualifying assets placed in service in 2025, with a phase-out starting at $4 million in total purchases. This is more than double the previous limit, and both thresholds will adjust annually for inflation. The deduction applies to most depreciable personal property, including CNC machines, robotics, computer hardware and peripherals, commercial software, certain vehicles, and qualified improvement property for building improvements.
Bonus depreciation has been restored to 100% for qualifying assets acquired and placed in service after January 19, 2025. Previously, bonus depreciation was scheduled to decrease to 40% in 2025 and 20% in 2026 before expiring. The OBBBA makes 100% bonus depreciation permanent for property placed in service after January 19, 2025.
The January 19 cutoff is important. Equipment placed in service before January 19, 2025, is subject to the previous 40% bonus depreciation rate, not the new 100% rate. Section 179 can help offset this difference, and the interaction between these provisions offers planning opportunities for equipment acquired during this period. Careful calculation is necessary to optimize deductions.
The OBBBA introduced 100% first-year depreciation for Qualified Production Property (QPP), which applies to nonresidential real property used in qualified production activities such as manufacturing, agricultural production, chemical production, and refining. Previously, these structures were depreciated over 39 years. Now, facilities that begin construction after January 19, 2025, and are placed in service before the end of 2030 may be eligible to fully deduct building costs in the first year.
This provision can significantly impact the financial analysis of domestic facility investments.
When using these provisions together, note that Section 179 is limited by taxable income and cannot create a net operating loss, while bonus depreciation can. In high-income years, Section 179 is typically applied first to maximize current-year benefits, with bonus depreciation used for the remaining amount. This interaction also affects interest expense limitations under Section 163(j), the QBI deduction, state conformity, and lender covenants tied to EBITDA. Analyzing these provisions in isolation may lead to unexpected outcomes elsewhere in your tax return.
State and Local Incentives: Where the Negotiating Gets Real
Federal tax planning is primarily rules-based, with established rates, limits, and phase-outs. In contrast, state and local incentives are often negotiated. Manufacturers who secure the most value typically engage in incentive discussions before finalizing site decisions.
States are highly competitive in attracting manufacturing investment. Incentive programs generally fall into several key categories:
Capital investment credits support facility construction and equipment acquisition. For example, Alabama offers an annual credit of 1.5% of qualified capital investment costs for up to ten years. New York’s Excelsior Jobs Program provides wage credits of up to 6.85% for companies that create at least 5 jobs and invest at least $500,000. Ohio offers a refundable Job Creation Tax Credit based on payroll for new positions. Most states have similar programs, and terms can often be more favorable than published guidelines when significant investment and job creation are involved.
Property tax abatements can provide significant savings. For example, a facility with $5 million in assessed real property could save several hundred thousand dollars over ten years with a 50% abatement on non-educational property taxes. These savings may not appear in income tax projections but can materially affect investment decisions. In several states, local jurisdictions can negotiate abatement terms directly, so working with Industrial Development Agencies or similar entities may yield additional benefits beyond those offered by published state programs.
Sales tax exemptions on manufacturing equipment and production inputs can substantially reduce capital costs. Most states with a strong manufacturing presence exempt machinery and equipment used directly in production, though definitions vary. Some states also exempt utilities consumed in manufacturing, while others do not. Misapplying these rules can be costly, and correcting errors for prior years often requires formal refund claims that are subject to increased scrutiny.
Workforce development grants and training credits are increasingly important as manufacturers invest in automation and skilled trades. Programs such as Georgia’s Quick Start, which offers no-cost customized training for new and expanding operations, can be more valuable than tax credits, especially for manufacturers hiring large numbers of employees.
State conformity with federal tax provisions is not automatic. For example, while immediate expensing under Section 174A applies federally, several states have not adopted the OBBBA provisions. As a result, you may deduct R&E costs immediately on your federal return but still amortize them for state purposes, creating state-only taxable income that requires separate tracking and estimated tax calculations. This can result in an effective tax rate different from your federal tax rate. For multi-state manufacturers, addressing state conformity is essential for effective tax planning.
Advanced Manufacturing Credits and Domestic Production Incentives
Manufacturers in certain production categories may qualify for federal production-based credits that extend beyond standard depreciation and deductions. It is important to review these credits even if your operation does not appear to fit the typical profile.
Section 45X, the Advanced Manufacturing Production Credit, remains one of the most valuable provisions in the code for eligible manufacturers. It provides per-unit credits for domestic production and sale of eligible clean energy components: solar cells and modules, battery cells and modules, inverters, electrode active materials, and qualifying critical minerals. The OBBBA preserved the core credit for solar, battery, and critical mineral manufacturers while accelerating the phase-out for wind components and adding a new phasedown for critical minerals starting in 2031.
One major improvement: the OBBBA increased the Section 45X credit for domestic manufacturing of semiconductors and semiconductor devices from 25% to 35% for property placed in service after December 31, 2025. Combined with the enhanced Section 48D investment tax credit for semiconductor fabrication facilities, available for those that begin construction by the end of 2026, the incentive structure for U.S.-based semiconductor manufacturing is now substantial.
The Section 45X credit is transferable, allowing manufacturers who cannot fully utilize it to sell the credit. The market for transferable credits has matured significantly, and 45X credits are among the most liquid. If you have unused credits from eligible production, consider discussing monetization strategies.
Manufacturers operating in Qualified Opportunity Zones continue to benefit from incentives that reward long-term investment. While gain deferral benefits are no longer available for new investments, the permanent exclusion from tax on appreciation for investments held ten years or more remains. For manufacturers in designated zones, this benefit, combined with state and local incentives, can be highly advantageous.
The Qualified Business Income (QBI) deduction under Section 199A continues to benefit pass-through manufacturers, including S corporations, partnerships, and sole proprietors, by allowing a deduction of up to 20% of qualified business income. The OBBBA increases this deduction to 23% beginning in 2026. For example, a manufacturing S corporation with $1 million in QBI would see a $230,000 reduction in taxable income. The deduction requires proper entity structuring and W-2 wage documentation and is subject to wage and capital limitations above certain income thresholds.
Uniting It All: The Planning Mindset That Makes the Difference
Most manufacturers miss out on tax benefits not because of a lack of awareness, but because their tax planning is reactive rather than proactive. Delaying discussions about depreciation or state incentives until late in the process often results in missed opportunities.
Manufacturers who maximize benefits in the current environment consistently follow several best practices.
They conduct quarterly tax projections rather than annual ones. The interplay among 100% bonus depreciation, Section 174A deductions, interest expense limitations, and the QBI deduction means that mid-year decisions can have significant tax implications. Modeling these factors only at year-end limits the ability to make timely adjustments.
They approach state and local incentives as a negotiation rather than a routine filing process. When considering facility expansion, manufacturers should discuss incentives with state economic development offices before finalizing location decisions. The most favorable incentive packages are often negotiated rather than publicly listed.
They document R&D activities in real time. As Form 6765 requirements become stricter and IRS scrutiny increases, inadequate documentation can be costly. Integrating documentation into engineering and product development workflows, rather than reconstructing records at tax time, helps ensure successful credit claims and reduces audit risk.
They carefully evaluate the timing of capital investments. The new QPP depreciation provision, restored 100% bonus depreciation, and expanded Section 179 limits all favor capital investment in 2025 and beyond. If equipment purchases or facility construction are planned within the next three years, it is advisable to assess whether accelerating these investments would be tax beneficial.
The current tax code is highly favorable for domestic manufacturing. It is important to ensure your team is prepared to take full advantage of these provisions, rather than discovering missed opportunities after the fact.
Derrick Rebello is a partner at Gray, Gray & Gray, LLP, a business consulting and accounting firm specializing in the Manufacturing & Distribution industry.
The information in this article is intended for general informational purposes and does not constitute legal or tax advice. Tax laws are complex and subject to change; consult a qualified tax professional before making any decisions based on the provisions described here.
Frequently Asked Questions (FAQ)
It is not too late. For larger manufacturers, recovery occurs through your 2025 and 2026 returns: you may deduct all remaining unamortized domestic R&E costs in 2025 or split the deduction across both years, depending on which approach yields a better tax outcome. If your average gross receipts for those years were under $31 million, you may amend all affected returns to apply Section 174 as if the capitalization requirement never existed. All years must be amended together. For businesses that incurred significant tax liabilities during that period, the potential refunds can be substantial. The accounting method changes have specific IRS procedures and deadlines, so it is important to begin discussions with your advisor promptly.
It depends on when the equipment was placed in service. The 100% bonus depreciation under the OBBBA applies only to property acquired and placed in service after January 19, 2025. Equipment placed in service before that date is subject to the previous 40% bonus depreciation rate. However, Section 179, with its new $2.5 million deduction limit, can help offset the difference. For example, a $3 million purchase placed in service before January 19 could combine 40% bonus depreciation with a Section 179 election on the remainder, resulting in a better outcome than the 40% rate alone. The optimal approach depends on your specific tax situation, so it is important to model the options before filing.
This provision is beneficial at various investment levels, but it is especially impactful for large construction projects. It allows 100% first-year depreciation on factory buildings, which previously required 39 years of depreciation. For example, a $10 million facility that would have generated approximately $256,000 in first-year depreciation can now generate a $10 million deduction in the year it is placed in service, provided construction begins after January 19, 2025, and the facility is in service by the end of 2030. Even for smaller projects, the cash flow improvement is significant. Timing is critical: construction must begin within the specified window, so early planning is essential.
Assuming state returns follow federal treatment can be costly. State conformity to federal tax changes is not automatic. Several states have not adopted the OBBBA’s immediate expensing under Section 174A, so you may deduct R&E costs on your federal return but still amortize them for state purposes, resulting in state-only taxable income that requires separate tracking and estimated tax payments. Bonus depreciation conformity also varies; some states limit or disallow it. The best approach is to conduct a state-by-state conformity analysis as part of your 2025 tax planning, rather than discovering discrepancies during return preparation.
The core credit structure for solar component manufacturers remains unchanged, and for most categories, like solar cells, modules, inverters, battery cells and modules, and critical minerals, the credit continues without the accelerated phase-out now applied to wind energy components. Wind component credits will be eliminated for products sold after 2027, but this does not affect solar. However, new material-assistance rules now apply: beginning after 2025, components using materials, designs, or intellectual property from restricted foreign entities are ineligible for the credit. This creates new documentation and supply chain diligence requirements for solar manufacturers. If your supply chain involves China or other restricted jurisdictions, address compliance issues proactively.
Schedule a Consultation
For specific guidance on implementing these provisions for your manufacturing operation, consult with qualified tax professionals who specialize in the manufacturing and distribution industry. Contact Gray, Gray & Gray at (781) 407-0300 or complete the convenient form below.