The Section 199 deduction, also called the “domestic production activities deduction,” is intended to boost US jobs by encouraging domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But, this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.
Sec. 199 Deduction 101
A company calculates its Sec. 199 deduction by first determining its qualified production activities income (“QPAI”). QPAI is the net income from qualified production activities. A company computes its QPAI by taking its domestic production gross receipts (“DPGR”) and subtracting the cost of goods sold and other expenses allocable to DPGR.
Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t. If less than 5% of receipts do not qualify as DPGR, the company may treat all of the receipts as DPGR. Also, the company will need to allocate its expenses to those that directly and indirectly relate to the DPGR and those that do not relate to DPGR.
The Sec. 199 deduction is determined by multiplying the lesser of the qualified production activities income or taxable income by 9%. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production.
Some Qualifying Activities
The deduction is available to traditional manufacturers of tangible personal property. Other qualifying activities include the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. Computer software production and agricultural processing also may be eligible. You can also qualify from the lease, rental, licensing or sale of qualifying production property, such as:
- Tangible personal property (for example, machinery and office equipment);
- Computer software; and
- Master copies of sound recordings.
To qualify, the property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.
The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.
Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return. You can reach me at HZemel@BerdonLLP.com or contact your Berdon advisor.
Hal Zemel, a Tax Partner at Berdon LLP, New York Accountants, has nearly 25 years in public accounting and advises businesses in the manufacturing, distribution, advertising, and real estate sectors.