Tax Deductions for Businesses

Don’t Ignore the DPAD ― It May Work for You

The domestic production activities deduction (“DPAD”) is meant to encourage domestic manufacturing. It’s often called the “manufacturers’ deduction” (or “Section 199 deduction”). But, this potentially valuable tax break can be used by many other types of businesses other than manufacturing companies. This article explains the various acronyms associated with the DPAD.

Understanding the Acronyms

Before attempting to calculate the DPAD, it is helpful to understand the acronyms involved in the calculation. An essential factor is qualified production activities income (“QPAI”), which is the amount of domestic production gross receipts (“DPGR”) which exceeds the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t ― unless less than 5% of receipts aren’t attributable to DPGR.

DPGR can arise from a number of activities, including (but not limited to) the construction of real property in the United States, as well as engineering or architectural services performed domestically to construct real property. It can also result from the lease, rental, licensing or sale of qualifying production property, such as:

  • Tangible personal property (for example, machinery and office equipment),
  • Computer software, and
  • Master copies of sound recordings.

The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its own merits, the IRS has said that, if the labor and overhead incurred in the United States accounts for at least 20% of the total cost of goods sold, the activity will usually qualify.

Other activities can also qualify for the deduction, including some motion pictures and television programs — as long as at least 50% of the total compensation was paid for services performed by actors, production personnel, directors and others in the United States. In addition, some retailers can claim the DPAD to offset income they receive for cooperative advertising programs with vendors.

What activities will not qualify? Most sales of food and beverages, lease or rental of land, and customer and technical support expenses ― just to name a few.  Moreover, the DPAD is limited to 50% of Form W-2 wages paid to employees and allocable to DPGR. Most businesses won’t be able to claim the DPAD if there were no W-2 wages paid.  It would be possible, however, to get a flow-through deduction via another entity even if you ― or your business ― wouldn’t otherwise be eligible.

Simplifying the Calculations

While determining what costs are allocable to DPGR can become complicated, some smaller companies will be able to simplify their calculations. Under the Small Business Simplified Overall Method, costs are allocated between DPGR and non-DPGR based on relative gross receipts.

For example, say a company’s total cost of goods sold and other expenses is $200,000, its total gross receipts are $500,000, and, of this, $375,000 (or 75%) is attributed to DPGR. To determine its QPAI, the company subtracts $150,000 (or $200,000 × .75) from its DPGR of $375,000. That would result in a QPAI of $225,000.

This approach generally can be used by farmers who aren’t required to use accrual accounting, businesses with no more than $5 million in annual average gross receipts, and businesses that are eligible to use cash-basis accounting.

The Simplified Deduction Method, another method for calculating QPAI, can be used by most businesses whose assets are no more than $10 million, or whose average gross receipts don’t exceed $100 million. This approach is similar to the Small Business Simplified Overall Method described above in that most expenses are allocated between DPGR and non-DPGR based on gross receipts. But, the allocation isn’t used for cost of goods sold.

Do You Qualify?

If your business can claim the DPAD, you may be able to deduct 9% from the lesser of your QPAI or taxable income. As such, it could provide an increase to your cash flow. Ask your tax advisor for help determining whether and how the deduction could work for you.

 

 

 

 

 

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