Ramifications of removing the sec. 199 benefits-and-burdens test.

• Author: Pinneau, Trina

Section 102(a) of the American Jobs Creation Act of 2004, P.L. 108-357, enacted Sec. 199, allowing the domestic production activities deduction. Congress enacted the deduction to "improve the cash flow of domestic manufacturers and make investments in domestic manufacturing facilities more attractive," believing that doing so would "create and preserve U.S. manufacturing jobs" (H.R. Rep't No. 108-548, 108th Cong., 2d Sess., at 115 (2004)).

The original version of the deduction was phased in through 2009 and is currently equal to 9% of the lesser of the taxpayer's qualified production activities income (QPAI) or the taxpayer's taxable income. The amount of the deduction cannot exceed 50% of the taxpayer's Form W-2 wages for the tax year. To determine QPAI, a taxpayer must compute its domestic production gross receipts (DPGR). DPGR are the taxpayer's gross receipts that are "derived from any lease, rental, license, sale, exchange, or other disposition of qualifying production property [QPP] which was manufactured, produced, grown, or extracted [MPGE] by the taxpayer..., any qualified film produced by the taxpayer, or electricity, natural gas, or potable water produced by the taxpayer in the United States" (Sec. 199(c)(4)).

Taxpayers often enter into contractual arrangements with other parties to perform all or a portion of the activities required to produce QPP. This contractual relationship requires an analysis to determine which taxpayer is entitled to take the Sec. 199 deduction. Sec. 199(d) (10) directs Treasury to prescribe regulations to carry out the purposes of Sec. 199, including rules preventing more than one taxpayer from being allowed a deduction for a single activity. To limit the deduction to one taxpayer, Regs. Sec. 1.199-3(f)(1) requires that "only the taxpayer that has the benefits and burdens of ownership of the QPP" be treated as engaged in the qualifying activity. The determination of which party to the contract has the benefits and burdens of ownership is to be based on all relevant facts and circumstances. This analysis is often referred to as the benefits-and-burdens test.

Although Regs. Sec. 1.199-3(f)(4) includes three examples demonstrating the application of the benefits-and-burdens test, subsequent rulings and case law relied on varying factors, which made determining a taxpayer's eligibility for the deduction laborious and uncertain. This ambiguity burdened taxpayers that sought certainty as to the rightful...