DOMESTIC PRODUCTION ACTIVITIES DEDUCTION (DPAD)
- Manufacturing, Producing, Processing, Constructing?
- Architectural or Engineering Services?
- Farming or Agricultural Processing?
In 2004, Congress enacted the Domestic Production Activities Deduction starting in 2005. The value of that deduction has tripled in the ensuing years and may now significantly increase your client's tax savings. It allows businesses to take a deduction for certain “production activities” that you perform in the US.
What Kind of Activities?
The deduction was initially aimed at manufacturing businesses, but it also benefits construction firms, architectural and engineering firms, agricultural and mining enterprises, and numerous other businesses. Basically, if a taxpayer adds value to a product in the US and then sells, leases or licenses the product, it is likely eligible for this deduction.
This deduction was enacted to replace a manufacturing export tax incentive, but a business needn’t either manufacture or export. Simply put, one must “manufacture, produce, grow, or extract” (MPGE) “qualifying production property” (QPP) in whole or in significant part within the US.
MPGE is a broad category of qualifying activities, including: developing, improving, manufacturing (either from new material or from scrap, salvage, or junked material), processing, manipulating, refining, changing (from one form to another), combining, assembling, cultivating (as in earth/soil), raising livestock, mining minerals, fishing, growing crops, storage and handling of certain agricultural products, and certain installation services.
Add Value to What?
QPP is three things: tangible personal property, any computer software, and sound recordings. Other “things” besides QPP that can result in Domestic Production Gross Receipts (DPGR) are qualified films, electricity, natural gas or potable water produced in the US.
Other Qualifying Activities
Besides adding value to QPP through MPGE, a taxpayer’s qualifying DPGR can also include the construction of real property (in the US, of course) and engineering or architectural services for such construction. Therefore, all construction, architectural and engineering firms should be presented this opportunity for additional tax savings.
The deduction is 9% of a specially computed figure called “qualified production activities income” (QPAI) or the client’s taxable income (whichever is less) and cannot exceed 50% of the wages paid in the MPGE activities. Therefore, you need to know the client’s wages, its taxable income, and the split between its qualifying activities and those that do not qualify. This will enable a rough scoping of the client’s benefit to allow a fee quote that can be compared with probable benefits and the work necessary to compute and document those benefits.
What Papers are Needed?
- Income Tax Returns
- Year End Trial Balances
- Chart of Accounts
- COGS Details
Capturing the §199 deduction can become a complex and time consuming process. If the deduction is calculated incorrectly or lacks substantiation, your business could face additional taxes, penalties, and interest.
ETS can help your company ensure identification of all eligible activities as well as the most accurate calculation of the deserved deduction. Typical requirements include:
- Documentation for qualifying activities and income
- Proper allocation method for non-qualified income and embedded services
- Consistent allocation method for §861 apportionment of deductions
- Application of the wage and income limitations
- Calculations in IRS-ready format
ETS has a detailed and proven work plan to guide any given DPAD engagement to completion as well as expertise in defending IRS audits of this new deduction.
Contact us here or call us at 561-253-6640.