The Manufacturers Deduction

1
The Manufacturers Deduction

• IRC 199
• Effective January 1, 2005

2
The Manufacturers Deduction

• Complex!!!!!!!
• New Form 8903
• Over 125 pages of regulations issued in late
  October 2005
• The name is a misnomer---many of your clients
  will qualify for this new deduction
• A cost accounting nightmare for larger companies

3
Income Attributable to Domestic Production
Activities

• A taxpayer may deduct
• 3, for taxable years beginning in 2005 or 2006
• 6, for taxable years beginning in 2007, 2008,
  2009
• 9, for taxable years beginning in 2010
• OF

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• The lesser of
• Qualified Production Activities Income (QPAI)
• Or
• Taxable Income (AGI for individuals)
• However, the amount of this deduction cannot
  exceed 50 of the W-2 wages of the employer for
  the taxable year

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Calculation of Deduction

• QPAI 80,000
• TI 160,000
• Wages 30,000
• 2005 QPAD ?????

(3 80,000 2,400)
(3 160,000 4,800)
(50 30,000 15000)
2,400
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Qualified Production Activities Income

• Excess(if any) of
• Domestic Production Gross Receipts (DPGR)
• Over
• The Sum of the cost of goods sold (CGS), Direct
  Deductions, and Indirect Deductions allocable to
  such receipts

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Qualified Production Activities Income

• Computed on an item by item basis, not on a
  division by division basis, or product line by
  product line basis
• QPAI can be positive for one item, and negative
  for another

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QPAI-Definition of item

• Example 1-the soles
• Example 2-Purchased and manufactured shoes
• Example 3-Toy cars

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QPAI-Allocation of Gross Receipts

• A taxpayer must determine the portion of its
  gross receipts that is DPGR and which part of its
  gross receipts that is non-DPGR
• Exception-A taxpayers gross receipts may be
  treated as DPGR if less than 5 of the taxpayers
  total gross receipts are non-DPGR

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Domestic Production Activity Deduction

• Amount of Deduction
• Limited to 50 of W-2
• wages (Box 1 plus
• retirement fringes)
• Deduction allowed
• for AMT

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Domestic Production Activity Deduction

• DPGR Includes
• MPGE in U.S. of tangible property, computer
  software, or sound recordings
• U.S. construction
• U.S. engineering or architectural services
• Film production
• Electricity, natural gas, or potable water
  production

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Domestic Production Activity Deduction

• DPGR Excludes
• Sale of food or beverages at
• retail locations
• Transmission of electricity,
• natural gas, or water
• Property leased to
• related person

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Definition of Trade or Business?

• Material participation required?
• Which meaning?
• Farm income averaging
• 179 depreciation
• SE earnings
• Surviving spouse
• Passive income

14
Manufactured in U.S.

• In significant part
• Does not include
• Packaging, labeling,
• and minor assembly
• Design, development, or creation of
• intangible property

15
MPGE

• Should be producer for 263A
• 263A does not qualify producer for 199
• MPGE includes
• Farming
• Creating QPP
• Creating QPP from scrap material

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Tangible Personal Property

• Tangible property - not real estate
• Excludes intellectual property unless
  specifically stated
• Computer software
• Sound recordings
• Film production
• Electricity, natural gas, and potable water

17
Construction

• Relate to real property
• Performed by taxpayer
• in construction
• trade or business
• TP must engage in construction activities
• Gross receipts must come
• from construction

18
Real Property

• Residential or commercial
• Permanent structure (can include wiring, central
  air, etc.)
• Permanent land improvement (swimming pools,
  parking lots, etc.)
• Infrastructure
• Must exclude land

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De Minimus Exception

• 5 of real property sale can be for appliances,
  furniture, etc.

20
Food and Beverage Sales

• Food processing OK
• Sale in retail store not qualified
• Sausage made in
• butcher shop OK
• Sausage made by chef
• to sell as specialty dish
• in restaurant does not qualify
• 5 de minimus rule

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Gross Receipt Allocation

• Reasonable manner
• Use most accurate information
• Method used for internal management
• Time, burden, and cost of method
• Consistent use of method

22
Embedded Services

• Qualified warranty exception

23
Computer Software

• Software code
• Tangible media

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Cost Allocation

• CGS
• Directly allocable
• costs (direct)
• Ratably allocable
• costs (indirect)

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Allocation Methods

• 861 method
• Gross Receipts gt 25 million
• Simplified deduction method
• Gross Receipts lt 25 million
• Small business simplified overall method
• Gross Receipts lt 5 million

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Wages Paid Limitation

• 50 of W-2 wages, plus
• Employee salary reduction contributions
• Designated Roth
• contributions (2006)

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Three Methods

• Unmodified box method
• Modified Box 1 method
• Tracking wages method

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Unmodified Box Method

• Lesser of
• Box 1 or Box 2 and Box 5

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Modified Box 1 Method

• Box 1 wages of all employees
• Minus wages not taxable for Fed W/H taxes
• Plus employee salary reduction contributions. (D,
  E, F, G, or S)

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Tracking Wages Method

• Same as modified Box 1 method except only
  employees of taxpayer are included
• Method must be used if short year applies

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Expanded Affiliated Groups

• IRC 1504(a)
• Must substitute 50 for 80

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Pass-through Entities

• Deduction determined at K-1 level
• New K-1 with codes O, P, and Q in Box 12

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Prepare for the Deduction

• Does the taxpayer qualify?
• Look at the primary issues