The American Jobs Creation Act, signed
into law in 2004, includes a tax benefit
for certain domestic production activities. Designed to aid small U.S. manufacturers that are engaged in domestic production,
the tax deduction can benefit a wide swath
of businesses ranging from software firms to
construction companies.
“The legislation enhances the ability of certain domestic businesses to compete in the
global marketplace,” says Valerie Colin, senior vice president of Gumbiner Savett Inc.
Smart Business spoke with Colin about
the domestic production activities deduction
and how to take advantage of the tax credit.
What is the domestic production activities
deduction?
An eligible taxpayer is allowed a deduction
for tax years beginning in 2005 or 2006 equal
to 3 percent of the lesser of the taxpayer’s
qualified production activities income for
the tax year or the taxpayer’s taxable income
(adjusted gross income in the case of an individual). The deduction increases to 6 percent for tax years beginning in 2007, 2008
and 2009 and to 9 percent for tax years
beginning after 2009. The deduction is subject to a 50 percent wage limitation. Every
business in the manufacturing industry
should be looking at this as a tax deduction.
Why was this tax deduction adopted?
This legislation was a part of the American
Jobs Creation Act of 2004, which enacted
IRC section 199, a new tax deduction, related
to domestic production activities. The legislation replaced the export tax benefit that
was ruled inconsistent with U.S. obligations
under various international trade agreements. It is available to all U.S. taxpayers that
qualify whether their sales are domestic or
foreign because the deduction, for the most
part, is based on where the goods and services are produced rather than sold. The legislation repeals the Extraterritorial Income
regime effective for transactions after Dec.
31, 2004, with certain transition rules.
What activities qualify for the deduction?
The tax deduction targets manufacturing
and production activities within the United
States. It incorporates a very broad definition of manufacturing. The act extends the
definition of manufacturing and production
to benefit handlers of agricultural products,
software companies, film production, construction companies, engineering firms,
architectural firms, and electric, gas and
water companies — in addition to typical
product manufacturers.
How is qualified production activities income
calculated?
Qualified production activities income
(QPAI) is an amount equal to the excess (if
any) of the taxpayer’s domestic production
gross receipts (DPGR) over the sum of: (1)
The cost of goods sold (CGS) allocable to
such receipts and (2) other expenses, losses
or deductions, other than the domestic production activities deduction, that are properly allocable to such receipts.
For a business with only one line of business, QPAI will be the same as gross income,
CGS will be the same as total cost of goods
sold and other expenses will be the same as
total expenses. For businesses with multiple
lines of business, these amounts will need to
be allocated.
In what ways has Congress eased the burden
of calculations for small manufacturers?
There are a couple of simplified formulas
that smaller taxpayers may use. There is
something called a ‘simplified deduction
method’ to allocate and apportion deductions between DPGR and non-DPGR, assuming some of your product is imported or produced overseas or you have multiple lines of
businesses, some of which qualify and some
of which do not. This is available to taxpayers
with average annual gross receipts of $25 million or less. The average is based on the three
taxable years prior to the current year.
In addition, there is a ‘small business simplified overall method’ to allocate the CGS
and deductions based on relative gross
receipts. These further simplified computations are available to those with average
annual gross receipts of $5 million or less.
How can a business best take advantage of
the credit?
If a company is a widget manufacturer producing all if its goods in the U.S., it’s very simple. For 2008, assuming there’s a profit, the
deduction would be 6 percent of the net
income before the deduction. Simply put, if
the net income before the deduction were
$100,000, the deduction would be $6,000,
therefore, the taxable income would only be
$94,000. In this example, the total wages
would also need to exceed $12,000 since the
deduction is limited to 50 percent of wages.
The deduction requires information to be
reported on Form 8903. When a company
has several different types of activities, some
of which involve U.S. manufacturing, some
outside the U.S., etc., it is best to consult with
your CPA.
Once you understand the ins and outs of
what qualifies and how the allocation formulas work, you may be able to restructure
some of your operations or materials purchases to maximize the deduction by increasing the percentages of domestic activities.
The more complicated the business, the
more likely some additional cost accounting
mechanisms may need to be implemented to
capture the most deductions.
VALERIE COLIN is senior vice president of Gumbiner Savett Inc. Reach her at (310) 828-9798 or [email protected].
