Preface: The Section 199 deduction is a tax deduction for manufacturing and other qualifying business activities. Situational exclusiveness sometimes is relevant to this tax deduction. This article is written to bring awareness to tax savings you need to ensure you obtain should your business qualify.
In 2004, President Bush signed into law the American Jobs Creation Act and with it a tax deduction that is highly unique and beneficial for qualifying businesses. The tax deduction is the Section 199 manufacturer’s deduction or the Domestic Production Activities Deduction (DPAD). Section 199 is available for corporations (S-Corporations and C-Corporations), partnerships, and LLC’s (multi-member and sole proprietorships.)
What is unique about Section 199? First, it has a multitude of applications. Although it is commonly referred as the manufacturer’s deductions, DPAD is available for qualified computer programming, qualified filming and sound recording, production of bottled water, or say even architectural and engineering services. In fact, Section 199 is available for all tangible personal property except buildings and land. Food processing activities for wholesale qualify for a DPAD deduction, unless they are prepared at a retail establishment, i.e. restaurant or market stand. Qualified manufacturing activities encompass manufacturing or production of inventory, installation of new product, or growing crops. Farmers even qualify for the Section 199 manufacturing deduction.
Construction contractors who are involved in substantial renovations, that increase property value, prolong property life, or adapt the property to new or different uses can use Section 199. So if you are a roofer or plumber, working on new construction, you could save on taxes with a Section 199 deduction. A remodeling contractor or swimming pool contractor who adds property value, also qualifies for the deduction.
How does Section 199 work? The domestic production activities deduction (DPAD) qualifies a company’s eligible domestic production gross receipts (DPGR) and qualified production activities income (QPAI) and W-2 wages as the metrics relevant to the expense. DPAD expenses for 2015 are the lesser of i) 9% of business qualified production activities income ii) 9% of taxable business income, or iii) 50% of eligible taxpayers W-2 income.
If 555, LLC has architectural service qualified production activities income $500,000 for the year and $600,000 of taxable business income, and $1,000,000 of qualifying W-2 wages, the DPAD deduction of Section 199 benefit would be the lesser of i) $45,000 (9% of $500,000 QPAI), ii) $54,000 (9% of $600,000 business income) or, iii) $500,000 (50% of W-2 wages. So in this example $45,000 would be the lesser number and the DPAD deduction. In 30% tax bracket, the LLC members net tax savings would be more than $13,000.
Let’s say Floors, Inc. has $70,000 of QPAI, $120,000 of business income, and $100,000 of W-2 wages. The DPAD deduction would be more than $6,000 (9% of 70,000.) In a 30% tax bracket Floors, Inc. shareholders would save more than $1,800 in tax payments.
There are multiple Section 199 methods including – small business simplified overall method, simplified deduction method, and Section 861. Your CPA will optimize the appropriate methodology for your business. If your business qualifies for Section 199 you don’t want to overlook this deduction.
Summary: Section 199, domestic production activities deduction, or manufacturers’ deductions are all phrases for a tax deduction that can save thousands, or tens of thousands of tax dollars for a multitude of businesses. Call your CPA if you think your business may qualify for Section 199, or could qualify, and determine how much that tax savings could potentially be.