Section 199 of the US Tax Code defines the requirements for a business to take a tax deduction for certain production activities. This part of the tax code was designed to encourage business to start or expand manufacturing businesses in the United States. This is usually called the Domestic Production Activities Deduction (DPAD). This tax deduction can be applied to a wide number of companies. The company must produce income from products it produces and sells, leases, rents or otherwise offers to customers.
The deduction is limited to 9% of the income of the business from these sales. Any item that is produced, created, improved, grown, or extracted can qualify as a manufactured item. This deduction includes the production of tangible personal property including often overlooked categories such as art, crops, electricity, natural gas, water, films, videos, soundtracks, software, engineering or architectural plans, or construction of real property. Clearly, this deduction can apply to many different types of companies – but it does not include retail food sales.
The items don’t have to be manufactured from scratch, either. Recycled items can be used as long as they are turned into at least two different items. Items sold to be used by other companies’ later in manufacture or repair are also included under this law. These items must also be produced within the United States.
The other restriction on this deduction is that it is limited to 50% of the salaries paid out on W-2s and filed with the Social Security Administration. So, besides having income from production activities, a company must have paid out salaries to produce these items. This deduction currently expires in 2023 at the Federal level. Some states also offer this deduction to businesses as well.
The deduction is limited to 9% of your company’s total qualifying production activities income. This includes the income generated from manufacturing/production after costs are deducted. If this figure is $100,000, this means that a possible deduction of $9,000 might be available to your company. If you paid out $18,000 in covered salaries, then $9,000 would be available to you. If you paid out $9,000 in covered salaries, then $4,500 would be your deduction.
All types of companies qualify under Section 199. These include individuals, farming coops, C and S corporations, partners, member and owner partnerships, LLC’s, trusts, estates and beneficiaries. Nor is it necessary for a business to be only engaged in manufacturing or production. The deduction applies to both regular and alternative minimum taxes. Form 8903 is used to report this deduction.
Clearly this deduction can result in a decreased income tax expense for many companies. For more information, go here to view the Internal Revenue guidelines. You should also contact Fricke & Associates, CPA for an analysis of how your business can benefit from the Section 199 tax deduction.