Sec. 199 "benefits and burdens" analysis: key guidance.

• Author: Kowal, Christine

Subject to a W-2 wage limitation, the Sec. 199 deduction is computed as a percentage (generally 9% for 2010 and thereafter) of the lesser of a taxpayer's qualified production activities income (QPAI) or taxable income.

In general, a taxpayer's QPAI equals the excess of its domestic production gross receipts (DPGR) over the sum of the cost of goods sold allocable to those receipts and other expenses, losses, or deductions that are properly allocable to those receipts. DPGR includes the taxpayer's gross receipts from any lease, rental, license, sale, exchange, or other disposition of qualifying production property that the taxpayer manufactured, produced, grew, or extracted (MPGE, or qualifying activity) in whole or in significant part within the United States; qualified films; and electricity, natural gas, or potable water produced by the taxpayer in the United States (hereinafter referred to collectively as qualifying property).

Taxpayers frequently enter into contractual agreements with unrelated parties to perform some or all of the activities to qualifying property (contract manufacturing). In general, only one taxpayer may claim the Sec. 199 deduction for any qualifying activity performed in connection with qualifying property Regs. Sec. 1.199-3(f)(1) provides that if a taxpayer performs a qualifying activity under a contract with another party, then only the taxpayer that has the benefits and burdens of the property during the period the qualifying activity occurs is treated as engaging in a qualifying activity The Sec. 199 regulations state that the analysis is to be based on all the facts and circumstances and provide examples illustrating certain factors that are relevant in determining which party has the benefits and burdens of ownership.

The IRS's primary objective with respect to any contract manufacturing arrangement is ensuring that only one party to the contract can claim to have the benefits and burdens during any qualifying activity This protects the IRS from being "whipsawed," i.e., being subject to claims by both parties to have the benefits and burdens during a qualifying activity.

Key Factors

The Sec. 199 regulations do not provide a list of factors to consider in applying the benefits-and-burdens test, but they do include two examples that illustrate how the facts-and-circumstances determination applies. These examples highlight several factors analyzed in determining which taxpayer to a contract possesses the benefits...