Until recently, software development and manufacturing have been very different industries. Under the recent Internal Revenue Code Section 199, Domestic Production Activity Deduction (DPAD), these industries may be meeting the same definition. This could mean a significant permanent tax deduction for software developers.
In general, a taxpayer may take a deduction against gross income equal to 9% of its qualified production activity income (QPAI). QPAI is determined by taking production gross receipts less cost of goods sold and other deductions allocated to this income. Production gross receipts means the taxpayer manufactured, produced, grew or extracted the product.
These produced gross receipts include those that are from the lease, rental, license, sale or exchange of computer software that was produced in the U.S. by the taxpayer. This is true even if the software sale is provided over the Internet.
To meet the definition of produced or manufactured under the safe harbor test, the labor and overhead costs incurred by the taxpayer should be greater than or equal to 20% of the total cost of the product. The use of computer software online by a customer is a service and not a lease, rental, license, sale or exchange of software. Therefore, income from these services does not qualify for DPAD unless one of the two exceptions is met:
- Gross receipts from providing computer software online can qualify if that taxpayer also derives gross receipts from the software by selling the same computer software affixed to a tangible medium or downloaded from the internet.
- Substantially identical software is available on the market by an unrelated person.
If your business has claimed the 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. By examining previous year tax returns, you may realize even more savings through additional DPAD qualifications. You must have proper documentation with accurate computations to support the deduction.
Looking for more tax planning and preparation services? Contact Marty Williams, CPA by calling (334) 887-7022 or by leaving us a message below.
