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Are Changes on the Way for the "Manufacturers’ Deduction”?

April 04, 2016

Recent IRS proposal addresses concerns and clarifies the “Manufacturers” deduction.

Though sometimes referred to alternatively as the “Manufacturers’ Deduction” or the “Domestic Production Activities Deduction” (DPAD), Section 199 of the tax code offers benefits to a number of qualifying individuals, not solely manufacturers. The deduction is not widely known, but could present valuable savings for you if you happen to be eligible.

Who can claim the deduction?

In addition to manufacturers, the following are eligible to claim this as well:

  • Construction contractors, architects, engineers, and software developers
  • Any business deriving revenue from manufacturing, producing, growing, or extracting (MPGE) “qualified production property” predominantly in the U.S.
  • Any business producing films that meet certain qualifications
  • Any business earning profit from producing domestic electricity, natural gas or potable water

The deduction generally equals 9% of a business’ qualified production activities income (QPAI), but is limited to 50% of the company’s W-2 wages that are attributable to qualified production activities. Oil-related qualified production activities income is limited to a 6% deduction.

Changes to regulations for contract manufacturers?

The Treasury Department has proposed modifying the existing rules surrounding the Section 199 deduction. In regulations that were proposed in August 2015, Treasury has focused on contract manufacturers (CM) and best practices for claiming the deduction as a CM.

What is a contract manufacturer?

Contract manufacturing is a form of outsourcing under which a contract manufacturer produces goods for a firm (called the “principal” in this relationship) under that firm’s label or brand.

Can CMs claim the deduction?

Since CMs produce the goods, they fit the eligibility requirement for the Section 199 deduction, but there has long been disagreement over who is actually justified in claiming the deduction- the contract manufacturer or the principal.

IRS regulations proposed in late August 2015 clarify that the deduction:

  • Can only be claimed by one party
  • Can primarily only be claimed by the contract manufacturer
  • Can be claimed by the principal under certain exceptions (which has been an area of dispute), namely if the firm purchased all the raw materials needed by the contract manufacturers to produce the product

Additional Changes to the Deduction

There are a few other changes as part of the IRS’ August proposal, including:

  • Modification of the existing definition of “qualified film” to include copyrights, trademarks, or other intangibles with respect to films
  • Clarification about how taxpayers calculate W-2 wages (for purposes of the deduction) in the case of a short taxable year
  • Read the complete list of changes

You will want to make sure you are not missing out on this potentially valuable deduction. Contact us to see if you are eligible, or to see if you have been taking full advantage of the deduction on your 2015 return.

To learn more read our blog, “The Manufacturers Deduction Isn’t Only for Manufacturers” which covers the deduction in detail.

Questions? Contact us.

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