News Releases
TAX ALERT
DOMESTIC MANUFACTURERS DEDUCTION
Dear Clients and Friends of the Firm:
The American Jobs Creation Act of 2004 created a new deduction (Code §199) for qualified domestic production activities (“QDPA”), which is referred to as the domestic manufacturers deduction. Pending final regulations, the Internal Revenue Service issued Notice 2005-14 to provide interim guidance.
The deduction is equal to a set percentage of QDPA income for the taxable year. The set percentage is of three percent for taxable years beginning in 2005 and 2006, six percent for taxable years beginning in 2007 through 2009 and nine percent in 2010 and thereafter. The deduction is limited to the applicable percentage multiplied by the lesser of the QDPA income or the taxable income for the year. The deduction is further limited to 50 percent of aggregate wages paid during the calendar year ending in the tax year.
The taxable income limit is determined after the calculation of the net operating loss deduction for the tax year; therefore a taxpayer with a net operating loss or a net operating loss carry forward is not able to claim the QDPA deduction. Taxable income is determined based on an expanded affiliated group concept.
QDPA income is equal to the excess of the taxpayer’s domestic production gross receipts for the year over:
- Cost of goods sold allocable to such receipts;
- Other deductions, expenses or losses directly allocable to such receipts; and
- A ratable share of other deductions that is not directly allocable to such receipts or another source of income.
Domestic production gross receipts generally includes the gross receipts of the taxpayer that are derived from the following sources:
- Any lease, rental license, sale or exchange or other disposition of qualifying production property, which was manufactured, produced, grown or extracted in whole or in significant part by the taxpayer in the United States of tangible personal property including software development and music recordings;
- Any qualified film produced by the taxpayer;
- Electricity, natural gas or potable water produced by the taxpayer in the United States;
- Construction performed in the United States or renovation of real property in the United States including residential and commercial buildings and infrastructure such as roads, power lines, water systems and communication facilities; or
- Engineering or architectural services performed in the United States for construction projects located in the United States.
For pass-through entities such as partnerships, limited liability companies and S corporations, the deduction is determined at the partner, member or shareholder level. Corporations under common control (an expanded affiliated group) consists of members of an affiliated group eligible to file a consolidated tax return, except that for purposes of the domestic manufacturers deduction, ownership is 50 percent instead of 80 percent. Certain companies that normally would be excluded from the group are now included. The deduction is determined by treating all members of the group as a single corporation. The deduction is allocated among the members in proportion to each member’s respective amount of qualified production activities income.
Domestic gross production receipts does not include gross receipts derived from the sale of food and beverages prepared by the taxpayer at a retail establishment nor from the transmission or distribution of electricity, natural gas or potable water.
Domestic production gross receipts generally include the gross receipts of the taxpayer derived from any lease rental license, sale or exchange or other disposition of qualified production property which was manufactured, produced, grown or extracted n in whole or in significant part of the taxpayer within the United States.
Notice 2005-14 provides that production activities for purposes of computation of the deduction are defined under IRC Section 263A.
As enacted, this new deduction leaves open many interpretive questions. Most of these have been answered by Notice 2005-14, however, most of the rules are based on fact and circumstances. Notice 2005-14 requires taxpayer to unbundle certain revenue streams and to test items that may not be considered domestic production gross receipts.
The planning for the domestic manufacturers deduction should be done by December 31, 2005. Should you have any questions about how this new deduction applies to you or need further explanation about aspects of this law please do not hesitate to contact us at 212-303-1800 or e-mail us at info@rssmcpa.com.
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