IRS Issues Chief Counsel Advice on Section 199 Deduction

The IRS released a Chief Counsel Advice (CCA) memo on 3/29/13 on whether a publisher of books can claim a Section 199 domestic production deduction for its activities of producing books. However, the IRS segregated the activities into all activities up to the printing stage, then separated out the printing stage itself, concluding that the printing stage is the only activity in which a qualifying manufacturing, production, growth or extraction (MPGE) activity occurs. All stages before that printing stage were in the IRS view non-qualifying as producing only intangible property and not tangible personal property.

However, the IRS advice was prepared for IRS Appeals and the Appeals Officer requested that Chief Counsel not opine on the benefits and burdens of ownership test; which is the key test in determining which party can claim the Section 199 deduction for the printing activities – if the publisher retains the benefits and burdens of ownership during this stage, then the publisher is awarded the Section 199 domestic production deduction; however it is gives up these rights and the printer is the entity possessing the benefits and burdens during this stage, then the printer rightfully gets the Section 199 deduction. However, without this analysis, the CCA appears incomplete.

Another topic in this opinion is the overlap of Section 263A from which several key sections of Section 199 were derived; many taxpayers believe that a ‘producer’ under Section 263A should similarly be deemed a producer/manufacturer under Section 199 and cite the Tax Court case, Suzy’s Zoo vs. Commissioner, 114 T.C. 1 (2000), aff’d, 273 F.3d 875 (9th Cir. 2001). In Suzy’s Zoo, the taxpayer created greeting cards and developed all steps in the process, but contracted the printing stage to a third party printer. The Tax Court still concluded that the taxpayer (the publisher) was the producer of the final tangible personal property for purposes of Section 263A. In the CCA, the IRS tried to distinguish this case by concluding that there may be situations where a taxpayer is a producer under 263A and not under Section 199. However, it is unclear how the IRS makes this distinction.

Some of the ‘gray areas’ in the CCA may be attributed to the government preparing for trial in the first Tax Court case to hear these issues. Advo Inc. & Subs is a docketed Tax Court case that will likely address issues such as benefits and burdens and 263A similarities. Thus, the CCA is simply the IRS’ position on some (but not all) of these issues that will be heard during trial.

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