LB&I guidance on "benefits and burdens of ownership" analysis under sec. 199.

• Author: Anderson, Kevin D.
• Position: IRS Large Business & International Division

The IRS Large Business & International (LB&I) Division issued a directive (LB&I-4-0112-001), dated Feb. 1, 2012, that provides guidance to field examiners in determining whether a taxpayer conducting production activities under a contract manufacturing arrangement with an unrelated third party meets the benefits-and-burdens-of-ownership requirement outlined in the domestic production activities deduction rules under Sec. 199.

The benefits-and-burdens issue has generated considerable controversy between the IRS and taxpayers since the deduction was created by the American Jobs Creation Act of 2004, P.L. 108-357. The directive is intended to simplify and expedite the often complex and subjective facts-and-circumstances analysis that the Sec. 199 regulations require taxpayers to perform to determine whether they have met the benefits-and-burdens requirement.

Background

Under Sec. 199, taxpayers are allowed to deduct a specified percentage of the lesser of (1) qualified production activities income resulting from specified domestic production activities; or (2) taxable income determined without regard to the Sec. 199 deduction. For 2010 and later tax years the specified percentage is generally 9% (Sec. 199(a)(1)). As noted in the directive, taxpayers frequently enter into contractual arrangements with unrelated parties to perform some or all of the production activities potentially qualifying for the deduction. However, the rules governing the tax treatment of these arrangements under Sec. 199 stipulate that only one taxpayer may claim the Sec. 199 deduction for a particular activity. Specifically, Regs. Sec. 1.199-3(f)(1) provides that, if one taxpayer performs a qualifying activity under a contract with another party, then only the taxpayer that has the benefits and burdens of ownership of the property during the period the qualifying activity occurs is entitled to claim a deduction under Sec. 199 for that property.

According to the Sec. 199 regulations, determining which party meets the benefits-and-burdens requirement is based on all of the facts and circumstances. Regs. Sec. 1.199-3(f)(4) contains two examples illustrating various factors relevant to the benefits-and-burdens determination for nongovernment contracts (a third example involves a government contract). The two examples cite various ownership factors contained in the extensive body of case law addressing this issue, including whether the taxpayer owns the intellectual property...