Contact us

[ return to list ]

New Tax Guidance on the Manufacturing Deduction

The IRS recently released proposed regulations concerning the new “manufacturing” deduction. The new regulations expand on the guidance previously provided under Notice 2005-14. Until the new regulations are finalized, taxpayers may rely on either the proposed regulations or Notice 2005-14.

As a result, your company may be able to choose the most favorable approach in certain situations.

Background: The American Jobs Creation Act of 2004 created a new deduction equal to 3% of the taxable income from the lesser of domestic production activities or taxable income. This deduction, which is first available on 2005 returns, will increase in stages until it reaches 9% in 2010. Following are several of the most important aspects of the new proposed regulations.

1. Qualified production activities income: The new proposed regulations clarify the methodology for computing qualified production activities income (QPAI), including matching income and expenses. For instance, if gross receipts and corresponding expenses occur in different tax years, the taxpayer's accounting method will determine when the receipts and expenses should be taken into account.

However, there is no relief from the requirement of applying QPAI on an item-by-item basis. If a company's product does not qualify as an item, the company can still treat any portion of the product that meets the requirements as an item in determining QPAI.

2. Wage limits: The new deduction is limited to 50% of a taxpayer's W-2 wages. Under the proposed regulations, payments to independent contractors, self-employment income and guaranteed payments made to partners are not included in the computation of W-2 wages. Furthermore, the same W-2 wages cannot be claimed in different tax years or by different taxpayers.

Domestic production gross receipts: The new regulations also establish standards for calculating domestic production gross receipts (DPGRs). Taxpayers may use any “reasonable” method of allocating gross receipts that accurately identifies those receipts. However, if a taxpayer is able to use a method specifically identifying where an item was manufactured without incurring significant costs, the taxpayer must use that method.

3. Installation activities: There has been considerable confusion concerning the installation of qualifying production property (QPP). If a taxpayer manufactures, produces, grows or extracts QPP and installs the property while still owning it, the gross receipts from the activity count as DPGRs. However, if ownership is transferred to another party before the property is installed, the gross receipts will not qualify.

4. Construction activities: Under Notice 2005-14, a taxpayer can qualify for the Section199 deduction for construction activities if it meets certain standards under the North American Industry Classification System (NAICS). The new regulations allow a taxpayer to qualify even if the construction activity is not its primary business activity. In addition, the regulations ease the safe-harbor rule for tangible personal property sold as part of a construction project.

New rule: If gross receipts derived from non-construction activities comprise less than 5% of the total gross receipts from a construction project, the total gross receipts count as DPGRs from construction.

5. Engineering and architectural activities: Only engineering and architectural services relating to real property can qualify for the manufacturing deduction. The regulations specifically require taxpayers performing these types of services to be regularly engaged in them, according to the NAICS codes.

Of course, this is just a brief summary of the new regulations. Be sure to obtain more details with respect to your situation.

[ return to list ]




	[ return to list ] New Tax Guidance on the Manufacturing Deduction The IRS recently released proposed regulations concerning the new “manufacturing” deduction. The new regulations expand on the guidance previously provided under Notice 2005-14. Until the new regulations are finalized, taxpayers may rely on either the proposed regulations or Notice 2005-14. As a result, your company may be able to choose the most favorable approach in certain situations. Background: The American Jobs Creation Act of 2004 created a new deduction equal to 3% of the taxable income from the lesser of domestic production activities or taxable income. This deduction, which is first available on 2005 returns, will increase in stages until it reaches 9% in 2010. Following are several of the most important aspects of the new proposed regulations. 1. Qualified production activities income: The new proposed regulations clarify the methodology for computing qualified production activities income (QPAI), including matching income and expenses. For instance, if gross receipts and corresponding expenses occur in different tax years, the taxpayer's accounting method will determine when the receipts and expenses should be taken into account. However, there is no relief from the requirement of applying QPAI on an item-by-item basis. If a company's product does not qualify as an item, the company can still treat any portion of the product that meets the requirements as an item in determining QPAI. 2. Wage limits: The new deduction is limited to 50% of a taxpayer's W-2 wages. Under the proposed regulations, payments to independent contractors, self-employment income and guaranteed payments made to partners are not included in the computation of W-2 wages. Furthermore, the same W-2 wages cannot be claimed in different tax years or by different taxpayers. Domestic production gross receipts: The new regulations also establish standards for calculating domestic production gross receipts (DPGRs). Taxpayers may use any “reasonable” method of allocating gross receipts that accurately identifies those receipts. However, if a taxpayer is able to use a method specifically identifying where an item was manufactured without incurring significant costs, the taxpayer must use that method. 3. Installation activities: There has been considerable confusion concerning the installation of qualifying production property (QPP). If a taxpayer manufactures, produces, grows or extracts QPP and installs the property while still owning it, the gross receipts from the activity count as DPGRs. However, if ownership is transferred to another party before the property is installed, the gross receipts will not qualify. 4. Construction activities: Under Notice 2005-14, a taxpayer can qualify for the Section199 deduction for construction activities if it meets certain standards under the North American Industry Classification System (NAICS). The new regulations allow a taxpayer to qualify even if the construction activity is not its primary business activity. In addition, the regulations ease the safe-harbor rule for tangible personal property sold as part of a construction project. New rule: If gross receipts derived from non-construction activities comprise less than 5% of the total gross receipts from a construction project, the total gross receipts count as DPGRs from construction. 5. Engineering and architectural activities: Only engineering and architectural services relating to real property can qualify for the manufacturing deduction. The regulations specifically require taxpayers performing these types of services to be regularly engaged in them, according to the NAICS codes. Of course, this is just a brief summary of the new regulations. Be sure to obtain more details with respect to your situation. [ return to list ]
2423-B Plantation Center Drive, Suite B, Matthews NC 28105 Fax:704-845-0928 © Copyright 2004 Desai & Desai, LLP