New tax incentive benefits U.S. production activity: Section 199 of the American Jobs Creation Act of 2004 is referred to as a "manufacturing deduction," and many companies may not realize that its benefits apply to some business segments that are quite distinct from traditional manufacturing.

• Author: Conjura, Carol
• Position: Taxes

Much of the attention given to the American Jobs Creation Act of 2004 focused on its one-time benefit for repatriating income earned in foreign jurisdictions. But there's another part of the law that provides an annual, recurring benefit: Section 199.

This provision allows companies a special income tax deduction computed on the basis of net income attributable to specified production and other activities conducted in the U.S. Unlike certain other provisions in the Jobs Act, Section 199's recurring benefit makes it an important area of focus for companies for not only 2005, but also, going forward, for future planning. There are a number of specific reasons, including:

* Heightened standards of tax and audit recordkeeping (including Sarbanes-Oxley requirements, as well as strict Internal Revenue Service (IRS) substantiation requirements) have prompted many companies to establish sound procedures for identifying and capturing the necessary information relevant to the provision's calculation.

* The permanent nature of the benefits available under Section 199 has made it necessary to establish procedures for monitoring its impact on financial statements.

* Although 2005 is the first year the deduction is available, tax departments have sought to refine their calculations of the benefits for purposes of making estimated tax payments, as the potential tax impact has increased during the year.

* The establishment of sound data collection and computational processes will be vital as the rate of benefit increases over the next several years.

General Scope

Since the deduction is often colloquially referred to as the "manufacturing deduction," many companies still may not realize that its benefits apply to some business segments that are quite distinct from traditional manufacturing. Indeed, the industries affected are diverse, and include traditional manufacturing, software, media (including print and film), utilities and construction (including engineering and architecture).

In some cases, application of the benefit can arise in unexpected places. For example, a service provider--such as a consultant or logistics company that also licenses self-developed software to its customers--may be able to claim the deduction. A restaurant chain that operates offsite centralized food preparation facilities may be able do so as well.

Calculating the Deduction

As background, to calculate the deduction (in general terms), gross receipts attributable to eligible domestic activities ("domestic production gross receipts") are aggregated and offset by allocated expenses and (where applicable) cost of goods sold to arrive at "qualified production activities income." This amount is intended to represent taxable profit or loss for the relevant portion of the business, whether housed in an affiliated group of corporations or allocated to partners or S corporation shareholders.

Subject to a taxable income and 50 percent of wages limitation, the deduction for 2005 and 2006 equals 3 percent of qualified production activities income. The percentage increases to 6 percent for 2007 through 2009 and 9 percent for 2010 and later...