Highlights of the sec. 199 final regs.

• Author: Giacoletti, Timothy J.

The following overview discusses how the final Sec. 199 regulations (TD 9263, issued 5/24/06), compare to the proposed regulations (REG-105847-05, issued 11/4/05), and to Notice 200514 (issued 1/1/9/05). The final regulations were effective June 1, 2006, but can be applied to earlier tax periods.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), enacted May 17, 2006, has also changed certain Sec. 199 provisions with respect to qualified wages. Although the IRS and Treasury should probably be commended for trying to simplify this very complex area of the law, many ambiguities still exist, which may lead to disagreements between taxpayers and the Service on how to apply the law.

Computing Taxable Income

Beginning with tax year 2005, a new deduction is available to companies that produce goods within the U.S. The deduction, created by the American Jobs Creation Act of 2004, was enacted in response to the phased-out repeal of the extraterritorial income (ETI) exclusion.

Under previous pronouncements, the Sec. 199 deduction could not be taken into account in computing a net operating loss (NOL) or an NOL carryback or carryover. However, final Regs. Sec. 1.199-1(b)(1) clarifies that in calculating taxable income in the year of the deduction, taxable income is computed without regard to the Sec. 199 deduction or the ETI exclusion.

Wage Limit

The final regulations give the Secretary the authority to authorize methods of calculating Form W-2 wages (i.e., within revenue procedures such as Rev. Proc. 2006-22); see Regs. Sec. 1.199-2(e)(3). The authority was granted so that changes could be made more quickly than by waiting to amend the final regulations for future changes to Form W-2.

The final regulations also responded to many small taxpayers' concerns about the W-2 wage limit. Many of these taxpayers use professional employment organizations or employee leasing firms to give their employees the most beneficial and cost-effective benefits. Term employees (i.e., corporate officers and employees under common-law rules) are defined under Sec. 3121(d)(1) and (2), according to Regs. Sec. 1.199-2(a)(1). Regs. Sec. 1.199-2(a)(2) allows taxpayers to take into account amounts paid by and reported on Forms W-2 issued by other parties, provided the reported wages were paid to common-law employees. Thus, the issue of whether payments made to the "leased" employees are included in the W-2 wage limit depends on an application of the common-law...