Enacted in 2004, the American Jobs Creation Act included a tax relief provision for domestic manufacturers with the intent of stimulating manufacturing activity in the U.S. If a profitable business does any manufacturing, and a significant portion of its taxable income is generated from production activities within the U.S., it may qualify for a deduction equal to 9% of its qualified production activity income (QPAI). As a safe harbor, the significance requirement can be met if the taxpayer’s direct labor and overhead for the qualified U.S. production is 20% or more of the taxpayer’s cost of goods sold. The computation can be ridiculously simple or quite complex, depending on the nature of the business, but understanding the technicalities of the calculations can often produce an even greater deduction than what may have been already claimed. What may seem simple on the surface can be quite complex in maximizing tax deductions.
If your business has claimed the Domestic Production Activity Deduction (DPAD or Section 199 Deduction), check the Form 8903 filed with your tax return. If the amount on line 10b is less than taxable income, there may be opportunities for more DPAD than claimed. Even if your business passes that simple test, there may be even more deductions lurking under the surface of the calculation itself.
The Opportunity
With the DPAD at 9%, more businesses may find it worthwhile to recalculate and substantiate the deduction than in previous years when the percentage was lower. However, understanding the complex rules that govern the QPAI calculation is critical in maximizing available tax deductions. A simple first step is to determine if line 10b on Form 8903 is less than taxable income. If so, there are likely additional tax deductions available for all open tax years. Otherwise, there still may be more opportunities with an in-depth analysis of the QPAI computation. The statute of limitations for federal income tax returns is three years, so you may be able to amend years 2011 through 2013 in addition to an enhanced deduction for 2014.
If you are a partner or S-corporation shareholder in a manufacturing business and your Form K-1 does not show information for you to compute the DPAD on your personal tax return, there also may be an opportunity for the business to claim the DPAD.
The Benefit
Reviewing prior year tax returns for an additional DPAD could yield substantial savings. At 9%, a recalculated DPAD will yield about three cents of tax savings on every dollar of additional deduction found. There is very little risk in claiming the deduction since the amount is provided by statute. The key is in proper documentation and analysis with accurate computations supporting the deduction.
In addition, the DPAD applies to industries beyond manufacturing. It can apply to industries, including construction companies, software developers, engineering services related to U.S.-based projects, selling, leasing or licensing items that have been manufactured in the U.S. and the production of electricity, natural gas or water.
Machen McChesney can assist you with a comprehensive review to maximize tax opportunities. Looking for more business tax planning expertise? Contact Marty Williams, CPA by calling (334) 887-7022 or by leaving us a message below.
