Is your business taking full advantage of the Domestic Production Activities deduction?
This deduction – which can be as much as 9 percent of your U.S.-based business activity profit – is available to virtually every small business in the manufacturing industry.
A company engaged in the following business activities may qualify for the Domestic Production Activities (DPA) deduction. The items on this list are called “qualified production activities” (QPA):
The DPA deduction is limited to income arising from qualified production activities in whole or significant part based in the United States.
Under the “safe harbor” rule, businesses can take the deduction if at least 20 percent of the total costs are the result of direct labor and overhead costs from U.S.-based operations.
If any part of manufacturing or production activities is outside the United States, the business must use either the safe harbor rule (at least 20 percent of total costs are from U.S.-based production activities) or allocate costs using the facts and circumstances of the business.
The following lines of business are specifically excluded from claiming the DPA deduction:
The key to figuring the Domestic Production Activities deduction is to examine “qualified production activities income.”
Qualified production activities income (QPAI)
– Qualified production activities expenses
= Qualified production activities net income
X The QPA deduction amount of 9 percent
= The Tentative QPA Deduction
The qualified production activities deduction is all income arising from qualified production activities.
For a company with only one line of business, QPAI will be the same as gross income. For companies with multiple lines of business, income will need to be allocated. The same is true for qualified production activity expenses, which are all expenses directly related to the qualified production activities.
The dollar amount of the DPA deduction is limited. The deduction cannot exceed adjusted gross income (for sole proprietors and owners of partnerships, S corporations, LLCs) or taxable income (for C corporations). The deduction cannot exceed 50 percent of W-2 wages.
If you engage in contract manufacturing, you can claim the DPA deduction only if you have the benefits and burdens of ownership of the property while manufacturing activity occurs.
Which party in a contract manufacturing situation has the benefits and burdens of ownership is a factual question. The parties cannot designate by contract which one is entitled to the DPA deduction.
If a company enters into a contractual arrangement with a nonrelated party to perform some or all of the manufacturing activities, the following is a three-step process to determine who has the benefits and burdens of ownership.
Step 1: Review Contract Terms
Step 2: Analyze Production Activities
Step 3: Evaluate Economic Risks
Many taxpayers have overlooked this deduction, so if you think your activities may qualify, contact your tax adviser.