Taking Advantage of the Domestic Production Deduction
Posted 6-7-2011 | By Anthony Oster | Download Article
The domestic production deduction (DPD), enacted by the American Jobs Creation Act of 2004, has gradually phased-in from a 3% deduction for tax years beginning on or after January 1, 2005, to a 9% deduction for tax years beginning on or after January 1, 2010. The DPD has grown into a substantial deduction for taxpayers that have qualified activities.
The DPD is calculated by multiplying the annual applicable percentage (currently 9%) by the lesser of taxable income (adjusted gross income for individuals) or qualified production activity income. The deduction is further limited to 50% of the wages directly allocable to the qualified gross receipts.
In simplified terms, qualified production activity income is calculated as follows: gross receipts from the sales of qualified property and/or services, minus the cost of goods sold directly related to the production of the property and/or service, minus an allocable portion of all other expenses, deductions and losses.
The deduction is available to C-Corporations, S-Corporations, partnerships and individuals. The deduction for S-Corporations and partnerships are passed through to the owners and reported on their tax returns. The DPD is available to a wide variety of taxpayers performing any of the following qualified activities in whole or in part in the United States:
- Manufacturing, production, growth or extraction of tangible qualified production property
- Production of qualified films
- Production of electricity, natural gas or potable water
- Construction of real property
- Engineering or architectural services performed for construction projects of real property
Calculating the DPD begins with identifying any sales of goods or services that qualify for the deduction. Taxpayers should discuss their revenue accounts with their CPA to maximize the amount of the qualified sales.
Once it is determined a taxpayer has sales that qualify for the DPD, the taxpayer and their CPA should work together to determine all of the cost of goods sold; losses; and general, administrative and other expenses that need to be allocated or apportioned to the qualified sales. There are three different methods outlined in the IRS Regulations that can be used to allocate and apportion these expenses. The process can become very complex, but if the proper time is spent analyzing how the deductions should be allocated and apportioned, it can yield a larger deduction.
The qualified production activity income is then calculated by subtracting the allocable and apportionable expenses and losses from the qualified sales. And lastly, the deduction is calculated by multiplying the lesser of the qualified production activity income or taxable income with the applicable percentage (currently 9% for tax years beginning in 2010). As mentioned above, the deduction is further limited to 50% of the wages directly attributable to the qualified activities.
If you feel you may have sales that qualify for the DPD, please contact Anthony Oster, CPA, at aoster@hlbtr.com or 651-407-5852.