The Domestic Production Activities Deduction May Be for You
Does your business manufacture products in the US? Does your company employ US residents that work directly with the manufacturing of your product? If you answered “yes” to the previous two questions, your business will most likely be eligible for the Domestic Production Activities Deduction deduction – that will reduce your company’s tax liability for the applicable year.
The American Jobs Creating Act of 2004 provided for a new tax deduction related to domestic production gross receipts (“DPGR”) attributable to domestic production activities. DPGR is defined as gross receipts from services or products produced in whole or significant part within the United States. The deduction can be referred to as “domestic production activities deduction” (“DPAD”), “US production activities deduction”, or “domestic manufacturing deduction.” The DPAD is essentially a deduction equal to 9% of the lesser of the taxpayer’s taxable income or the qualified production activities income (“QPAI”). The DPAD replaced the previously established export tax benefit that was ruled inconsistent with the US obligations under various international trade agreements.
Who is eligible to claim the deduction?
The deduction is calculated at the entity level. Corporations, partnerships, S corporations, cooperatives, trusts, and estates may all take advantage of DPAD. It is based on the activity of the entity and either used to reduce the tax due at the entity level (corporations and cooperatives) or passed through to the owners for a credit on their individual returns (partnerships, S-corporations, trusts, and estates).
Figuring Domestic Production Gross Receipts
Certain types of receipts are considered eligible DPGR and qualify to be considered for the deduction under DPAD rules. The following is a list of gross receipts that are includable when computing DPGR:
- Any lease, rental, license, sales, exchange, or other disposition of qualifying production property that was manufactured, produced, grown, or extracted in whole or in major part within the US.
- Any lease, rental, license, sale, exchange, or other disposition of any qualified film.
- Any lease, rental, license, sales, exchange, or other disposition of any electricity, natural gas, or potable water produced within US.
- Construction performed in the US.
- Engineering or architectural services performed in the US for construction in the US.
There are certain gross receipts that are not eligible and do not qualify to be included in the DPAD calculation. They are as follows:
- The sale of food and beverage prepared at a retail establishment.
- The transmission or distribution of electricity, natural gas, or potable water.
- Property leased, licensed, or rented for use by any related person.
In order to meet the above requirements of eligibility, the manufactured product must be qualified production property. Qualified production property consists of tangible personal property, real property not including land, and construction projects of construction companies engaged in the trade or business of construction.
Calculating the DPAD can be fairly complex, depending on the nature of the business. The following are some basic guidelines used when calculating the deduction:
- A significant part of the product must be produced in the US in order to qualify for DPAD.
- If production costs incurred in the US account for more than 20% of the total manufacturing costs, the product qualifies to be included in the DPAD calculation.
- Qualified production activities income (“QPAI”) is figured by taking domestic production gross receipts (“DPGR”) reduced by the costs of goods sold that are allocable to those receipts and any other expenses indirectly allocable.
- DPAD is equal to 9% of the lesser of the taxpayer’s taxable income or QPAI.
- The deduction is then limited to 50% of W-2 wages paid by the employer during the tax year that are allocable to DPGR.
- DPAD is also available for AMT purposes and it is equal to 9% of the lesser of the QPAI or alternative minimum taxable income.
What’s the next step?
DPAD is an excellent method in rewarding your business with an additional tax deduction for domestic manufacturing activities. Business owners should evaluate the cost-benefit aspect of the deduction in order to determine overall benefit.