A Guide to the Domestic Production Activities Deduction

Although many companies are shipping their manufacturing processes overseas for cheaper labor and production costs, the U.S. has created a number of enticing incentives to keep your production business stateside. And one of those incentives was the Domestic Production Activities Tax Deduction — also known as Section 199. This deduction was available for tax years ranging from 2005 through 2017 and applied to businesses of all sizes. Let's take a closer look at the Domestic Production Activities Tax Deduction as well as the new deduction offered in its place. 

What Is the Domestic Production Activities Tax Deduction?

While often associated with the oil industry, the Domestic Production Activities Tax Deduction can be a powerful tool for manufacturing businesses as well as almost any business that:

• Produces goods mainly in the U.S.
• Extracts goods mainly in the U.S.
• Grows goods mainly in the U.S.
• Manufactures goods mainly in the U.S.
• Develops goods mainly in the U.S.
• Improves goods mainly in the U.S.

The Domestic Production Activities Tax Deduction is engineered to offer tax relief for a variety of businesses that create goods in the domestic U.S. instead of producing them overseas. Utilizing form 8903, eligible businesses were able to claim the domestic production activities deduction, which is based on a complex set of rules and formulas.

A Closer Look at Domestic Qualifying Production Activities

The term "domestic production activities" is sweeping and spans across a vast range of businesses. However, the IRS does provide clarity: your business must perform or undertake work in one of the following key categories:

• Videos and films must be 50% produced in the U.S.
• Natural gas, potable water, or electricity produced in the U.S.
• Construction performed in the U.S. 
• Engineering services offered in the U.S. for domestic construction projects
• Architectural services performed in the U.S. for domestic construction projects.
• The disposition of sound recording, tangible personal property, or computer software developed and/or created — either entirely or partially — in the U.S. 

What Are the Limitations and Tax Deduction Amounts? 

The highest credit amount you're able to claim under this deduction is 9% of the total income generated from the business. Because the ultimate goal of the deduction is to bolster employment and production in the US, only businesses who have employees are eligible to qualify. However, the Domestic Production Activities Tax Deduction carries two substantial limitations:

1. The total amount of the deduction must not exceed the total taxable income of the business.
2. You're only eligible to deduct up to half of the amount paid out to workers that are engaged in domestic production.

At the same time, business owners who operate a partnership, LLC, S corporation, or sole proprietorship are limited to deducting their adjusted gross income. 

Can the Domestic Production Activities Deduction Be Claimed After 2017 Tax Year?

No. The Domestic Production Activities Deduction can no longer be claimed for tax years after 2017. Instead, this tax deduction was replaced by the qualified business income deduction in 2017, which was a substantial component of the Tax Cuts and Jobs Act (TCJA) of 2017. Also known as the Section 199A deduction, this new deduction applies to owners of partnerships, S corporations, sole proprietorships — in addition to domestic manufacturing businesses.

Section 199 vs Section 199 A

Section 199A no longer only applies to domestic manufacturing companies. The newly passed Section 199A also allows business owners of partnerships, sole proprietorships, and S corporations to deduct up to 20% of qualified business income generated in a qualified business or trade. Although the Section 199A qualified business income deduction's purpose was altruistic, the legislative text and statutory construction are both confusing and ambiguous. Because of this, there has been significant controversy surrounding the enactment of Section 199A qualified business income deduction.

This new version of this popular deduction is more closely aligned to the Qualified Production Activities Income (QPAI) deduction, which is the part of income generated from domestic production and manufacturing eligible for a tax break. More specifically, qualified production activities income is the difference between the aggregate cost of service and goods and the manufacturer's gross domestic receipts. The Qualified Production Activities Income deduction is engineered to reward manufacturing businesses who produce products and goods domestically — in the US — instead of overseas. 

Contact the MB Group Today for Manufacturing Tax Planning Guidance

Navigating complex tax laws for manufacturing businesses can be confusing and seemingly impossible for an untrained professional. Fortunately, the CPAs, tax professionals, and accountants at the MB Group can help. We specialize in helping manufacturing businesses optimize their tax situation through strategic tax planning. When you partner with the MB Group, you'll immediately gain access to a team of tax professionals who are committed to minimizing your tax liability and ensuring you're not overpaying.

Contact the MB Group today