The Domestic Production Activities Deduction (DPAD) was created under Section 199 of the 2004 American Job Creation Act. Also referred to as the “Section 199 deduction” or the
The Domestic Production Activities Deduction (DPAD) was created under Section 199 of the 2004 American Job Creation Act. Also referred to as the “Section 199 deduction” or the “domestic manufacturing deduction,” this tax break is designed to help domestic manufacturers offset the costs of hiring new employees. The intent is to increase production in the United States and stimulate job growth in the manufacturing sector by way of tax incentives.
Qualifications and Limitations
The DPAD is available to manufacturers (with at least one employee) that earn income via goods manufactured, produced, grown or extracted in the United States, in whole or in significant part. Here, “significant part” isn’t strictly defined. A general rule of thumb is that the costs of producing, manufacturing, growing or extracting an item in the U.S. should be no less than 20 percent of the total cost of production.
Eligible Domestic Production Activities
These domestic production activities can include the manufacturing of:
- Food, including farming
- Music recordings and films
- Real Property
- Electricity, natural gas, potable water and minerals
The key is that the goods produced must be created from new or raw materials, or by combining at least two items to significantly change the nature of the original items. This definition means that a farmer who grows fruit qualifies, but a company that makes gift baskets containing fruit does not.
Eligible Business Types
It applies to all business entities, including sole proprietorships, partnerships, S-corps and C-corps. Sole proprietors without employees can incorporate their business and place themselves on the payroll to qualify for the deduction.
The Section 199 deduction can’t reduce a company’s income below zero and make it nonrefundable on its own. It can, however, be used to offset the alternative minimum tax. This can reduce your tax liability to zero and allow for other credits or deductions to provide a refund.
The only circumstance under which you will receive a DPAD refund is if you did not claim it in a prior year and have filed an amended return to include it.
Proposed Regulatory Changes
In 2015, the IRS proposed regulations that could impact certain manufacturers wanting to take advantage of this deduction for the 2016 tax year and beyond. Contract manufacturers who produce outsourced goods under a principal manufacturer would qualify for the Section 199 deduction on paper; however, there has been some confusion over whether the contractor or the principal can claim the items and the deduction. The proposed rules will allow only the contract manufacturer to claim the DPAD, since it is primarily responsible for producing the goods. There are exceptions, such as in cases where the principal purchased or otherwise provided the raw materials that were used by the contractor.
Calculating the Deduction
The Section 199 deduction is 9 percent of either your taxable income obtained from qualified production activities or your total taxable income for the year, whichever is less. It cannot be more than 50 percent of domestic production W-2 wages.
Calculations of your actual DPAD is completed via IRS Form 8903, but you can get an estimate by first subtracting the costs of goods sold via domestic production from your gross domestic production receipts to determine the company’s Qualified Production Activities Income. Multiply that figure by the 9 percent deduction rate to calculate a ballpark projection of your Section 199 deduction. Keep in mind that the DPAD is limited to 50 percent of domestic production wages. For example:
1 million Gross Domestic Product Receipts - $250,000 Domestic Production Costs = $750,000 Qualified Production Activities Income
$750,000 QPAI × 9% DPAD Rate = $67,500 DPAD
If domestic production wages are $100,000, the DPAD will be limited to $50,000.
The Section 199 deduction is one of the most effective ways for manufacturers to reducing their tax liability. The qualifications, calculations, exceptions and other regulations can be complex, however. It’s best to seek the expertise of a tax professional who specializes in manufacturing to ensure that you don’t miss anything pertaining to your specific business circumstances. By planning ahead, you can ensure the maximum deduction on your tax return. Contact the tax professionals at Goldin Peiser & Peiser to find out if your company can qualify for the Section 199 deduction.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.