A business with net income from “qualified production activities” is entitled to a tax deduction of 9% in 2010. This is a tax break designed to benefit companies that produce and pay wages domestically. However, the more complicated the business, the more complicated the math for calculating the “Domestic Production Activities Deduction,” as Section 199 comes with a very complex set of rules.
This deduction was created as part of the American Jobs Creation Act of 2004. A business with net income from a qualifying production activity was eligible to take a tax deduction of 3% in tax years 2005 and 2006. The deduction then increased to 6% for years 2007, 2008 and 2009, and is now 9% for years 2010 and beyond.
Which activities qualify and which don’t?
A business engaged in one of the following “qualified production activities” is eligible to claim the Domestic Production Activities Deduction under Internal Revenue Code Section 199:
- Manufacturing based in the United States,
- Selling, leasing, or licensing items that have been manufactured in the United States,
- Selling, leasing, or licensing motion pictures that have been produced in the United States,
- Construction services in the United States, including building and renovation of residential and commercial properties,
- Engineering and architectural services relating to a US-based construction project, or
- Software development in the United States, including the development of video games.
However, the following lines of business are specifically excluded from claiming the Domestic Production Activities Deduction:
- Construction services that are cosmetic in nature, such as painting.
- Leasing or licensing items to a related party.
- Selling food or beverages prepared at a retail establishment.
Figuring the Tax Deduction
The key to figuring the Domestic Production Activities Deduction is to first calculate “qualified production activities income” (QPAI), which is essentially all income arising from qualified production activities, less expenses related to such activity. For a company with only one line of business, QPAI will generally be the same as taxable income. For a company with multiple lines of business where some might qualify and others might not, the gross receipts and corresponding expenses must be allocated among the qualifying and non-qualifying business lines. The calculation can thus become much more complicated.
In a nutshell, the Domestic Production Activities Deduction is calculated as follows: Domestic Production Gross Receipts (DPGR)
minus Qualified production activities expenses
equals Qualified production activities income (QPAI)
times The QPA deduction amount of 9%
equals The Tentative QPA Deduction
The dollar amount of the Domestic Production Activities Deduction is subject to a couple of limitations. First, the 9% deduction amount is applied to the lesser of QPAI or regular taxable income. Second, the deduction cannot exceed the overall limitation of 50% of W-2 wages paid.
Example: A homebuilder here in Lee County with a single line of business has qualified production activity income of $500,000, regular taxable income of $600,000 and W-2 wages of $700,000.
9% of lesser of taxable income or QPAI $45,000
50% of W-2 wages $350,000
For 2010, the qualified production activity deduction would be $45,000. The deduction is claimed on Form 8903.
At HbK, our CPAs are well-versed with Internal Revenue Code Section 199. We also understand tax planning is essential for our clients’ financial success and we are proud to be proactive in maximizing the tax benefits you deserve.
Samantha M. Howes, CPA is a Senior Accountant with Hill, Barth & King LLC in the Fort Myers, Florida office. Samantha has worked as a consultant and a CPA helping clients in Fort Myers, Cape Coral, Naples and other Southwest Florida communities for the past 6 years. She has been with Hill, Barth & King LLC, a top 75 accounting firm, since 2004. Samantha can be contacted by phone at 239-482-5522 or email at firstname.lastname@example.org.