Business taxpayers can claim a domestic production activities deduction under Code Sec. 199 to offset income from domestic manufacturing and other domestic production activities.
The Code Sec. 199 deduction or DPD equals 9% of the smaller of—
- The taxpayer's “qualified production activities income” or QPAI, for the tax year, or
- The taxpayer's taxable income (modified adjusted gross income, for individual taxpayers), without regard to the Code Sec. 199 deduction, for the tax year.
Qualified production activities eligible for the deduction include items such as: the manufacture, production, growth or extraction of qualifying production property (i.e., tangible personal property such as clothing, goods, or food as well as computer software or music recordings) by a taxpayer either in whole or in significant part within the U.S.; construction or substantial renovation of real property in the U.S., including residential and commercial buildings and infrastructure such as roads, power lines, water systems, and communications facilities; and engineering and architectural services performed in the U.S. and relating to the construction of real property.
However, the domestic production deduction can't exceed 50% of the W-2 wages of the employer for the tax year. The wages must be allocable to the taxpayer's domestic production activities, and they include tips and other compensation as well as elective deferrals to 401(k) and other plans.
It is important for businesses to calculate the tentative Code Sec. 199 deduction and the W-2 deduction cap before year-end. If the deduction cap will limit the otherwise available deduction—for example, in the case of a closely held business whose owners do not draw substantial salaries—the business may want to bonus out additional compensation to maximize the deduction. Bear in mind that in some cases, an accrual basis corporation can deduct a bonus that is declared before year-end but not paid until the following year if 1) to employees owning less than 50% of stock and 2) bonus is paid within 2 1/2 months of end of tax year.
Taxpayers also need to factor the DPD into other year-end tax planning strategies. For example, when determining whether to defer or accelerate income, a taxpayer must determine the marginal tax rate for each year. For this purpose, the DPD will have the effect of decreasing the taxpayer's marginal rate.
About the Author
Sharon Sledzik, CPA, CGMA
Sharon Sledzik is a certified public accountant and serves as tax manager for Schlabig & Associates, Ltd. She has been with the firm since 2006. Her responsibilities include strategic tax support, research and tax planning for businesses, individuals, trusts, and non-profit organizations. (More about Sharon)