IRS Issues Regulations on Domestic Production Activities Deduction

Published date01 January 2016
Date01 January 2016
DOIhttp://doi.org/10.1002/jcaf.22131
117
© 2016 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22131
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IRS
IRS Issues Regulations on Domestic
Production Activities Deduction
Shirley Dennis-Escoffier
The Internal Revenue Service
(IRS) recently issued both tem-
porary and proposed regulations
providing guidance on several
different aspects of the domestic
production activities deduction.
These new regulations simplify
some of the complex areas of
the deduction by removing the
benefits and burdens test for
contract manufacturing; how-
ever, this change may not be
welcomed by corporations that
have structured their contracts
to meet this test. The regulations
also single out several activities
that the IRS does not believe
qualify as production activities,
including testing of products,
assembling of gift baskets,
and approval and payment of
invoices by general contractors.
There is some good news in that
these new regulations clarify the
computation of the wage limi-
tation for short tax years and
business acquisitions in a man-
ner that should reduce concerns
about the availability of the
deduction in these situations.
BACKGROUND
As part of the American
Jobs Creation Act of 2004,
Congress added Internal Rev-
enue Code (IRC) Section 199,
which created the domestic
production activities deduc-
tion (DPAD). This deduction
is computed as a percent-
age of the taxpayer’s profits
from domestic production
and increases as these profits
increase. To qualify for the
deduction, a taxpayer must have
gross receipts from qualifying
domestic production activities.
IRC Section 199(c)(4)(A)
states that domestic production
gross receipts (DPGR) include
receipts that are derived from
any lease, rental, license, sale,
exchange, or other disposition of:
1. Qualifying production prop-
erty (QPP) that was manu-
factured, produced, grown,
or extracted (MPGE) by
the taxpayer in whole or in
signicant part within the
United States;
2. Any qualied lm produced
by the taxpayer; or
3. Electricity, natural gas,
or potable water (utilities)
produced by the taxpayer in
the United States.
The deduction also applies
to construction of real property
performed within the United
States and the performance
of engineering or architec-
tural services related to that
construction.
QPP is defined in IRC
Section 199(c)(5) as tangible
personal property, computer
software, sound recordings,
and certain copyrights. Regu-
lation Section 1.199-3(e)(1)
states that MPGE also includes
installing, developing, improv-
ing, and creating QPP, making
QPP out of scrap, salvage, or
junk material as well as from
new or raw material by pro-
cessing, manipulating, refin-
ing, or changing the form of
an article, or by combining
or assembling two or more
articles.
Once a business deter-
mines its DPGR, it takes the
following steps to compute its
deduction:
1. Subtract cost of goods
sold and expenses from the
DPGR to determine the
qualied production activi-
ties income (QPAI).
2. Multiply the lesser of
QPAI or taxable income
by 9%.

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