The Section 199 deduction, also referred to as the domestic manufacturing deduction, is intended to encourage domestic manufacturing in the U.S. But this valuable tax break can also be used by many other types of businesses as well as manufacturing companies.

 Sec. 199 Deduction 101

The Sec. 199 was established by the American Jobs Creation Act of 2004 was created to ease the tax burden of domestic manufacturers deduction. For tax years beginning in 2010 and thereafter, the benefit is fully phased in at 9% of taxable income from the lesser of qualified production activities. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.

The deduction was originally intended for traditional manufacturers, but businesses engaged in activities such as architecture, engineering, construction, computer software production, and agricultural processing may also be eligible.

The deduction isn’t allowed in determining net self-employment earnings and largely cannot reduce net income below zero. Although, it can be used against the alternative minimum tax.

How Income is calculated
To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of Domestic Production Gross Receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.

DPGR can be found from a number of activities, including the construction of real property in the U.S., as well as architectural or engineering services performed stateside to construct real property. It can also result from the lease, rental, licensing, or sale of qualifying production property, such as:

  • Tangible personal property (for example, machinery and office equipment),
  • Computer software, and
  • Master copies of sound recordings

The property must have been manufactured, produced, grown, or extracted in whole or “significantly” within the U.S. While each situation is different, the IRS has said if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold then the activity normally qualifies.

Contact your advisor to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.