Global Tax Insights
Manufacturing Contracts: Who Gets the Section 199 Deduction?April 22, 2014
Taxpayers have long been confused about which party can claim the deduction, we clarify it here.
The Sec. 199 deduction — also known as the domestic production activities deduction or the manufacturers’ deduction — can provide a significant tax benefit. But when there’s a manufacturing contract involving unrelated parties, taxpayers have long been confused about which party can claim the deduction. Fortunately, the IRS recently released new guidelines that help clarify this issue.
Sec. 199 allows manufacturers (and certain other types of businesses, such as construction, engineering, architecture, computer software production and agricultural processing) to claim an income tax deduction for income derived from selling, leasing or renting qualifying property made in the United States. The deduction generally equals 9% of the lesser of a manufacturer’s qualified production activities income (QPAI) or its taxable income. It can reach as high as 50% of W-2 wages paid that are allocable to domestic production gross receipts.
If multiple manufacturers worked on the property, only one may claim the deduction. Last summer, the IRS issued guidelines for tax examiners to apply when determining which unrelated party in a manufacturing contract has the “benefits and burdens of ownership” of the qualifying property, which are required to claim the credit.
When deciding whether to challenge a taxpayer’s claimed Sec. 199 deduction, an examiner will request:
- A statement explaining the basis for the taxpayer’s determination that it had the benefits and burdens of ownership,
- A Certification Statement signed by the taxpayer, and
- A Certification Statement signed by the other party to the contract.
If these statements are provided, the examiner won’t challenge the taxpayer over the benefits and burdens of ownership. But if they aren’t provided, he or she will apply the traditional facts and circumstances approach to determine which entity bears the benefits and burdens of ownership and can claim the deduction.
Even with the guidelines, the process of determining which party to a manufacturing contract can take the deduction is complicated. We can help you make that determination and, if necessary, explain it to an examiner.