The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.
The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.
Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production, agricultural processing, and even health care applications also may be eligible.
The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.
To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.
DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:
The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.
A few of our dental practice clients are taking advantage of this deduction following the purchase of ceramic reconstruction equipment such as CEREC™ or other CAD/CAM technology. This qualifies as a manufacturing activity because the process mills materials to create a crown or other restoration. Milling is considered a manufacturing process that the IRS will allow. Patients love the convenience of being able to have work done in one visit, rather than taking an impression, sending it out to a lab, and then making a follow-up appointment for placement. The deduction is 9% of the net income from this activity, after deducting related costs, etc. Additional analysis by your CPA can determine if your activities qualify for this federal income tax deduction.
Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you're ready to file your taxes next year.