Calculation of the Section 199 Deduction
The Domestic Manufacturing Deduction (also known as the Section 199 Deduction) is based upon calculating the taxpayer’s QPAI – Qualified Production Activities Income. QPAI is defined on the 199 Overview section which consists of defining income from your qualified activity (producing tangible property, software, qualified films, real estate, construction, engineering or architectural work).
In defining your Qualified Production Activities Income or QPAI, this figure is calculated as follows:
- After identifying the qualified activity, you must allocate receipts between qualifying and non-qualifying receipts, known as DPGR (Domestic Production Gross Receipts) and non-DPGR.
- Allocate Cost of Good Sold (COGS) to your DPGR (qualified receipts) on a tax basis definition (i.e., applying uniform capitalization rules if applicable to your business).
- Allocate other direct and indirect costs to your DPGR – direct costs include P&L items such as marketing, advertising, and indirect costs are allocable costs such as corporate interest and overhead (G&A expenses).
- The above steps now equal QPAI or at least tentative QPAI because several important limitations and rules may apply before you can calculate the Section 199 deduction.
Section 199 Limitations and Related Rules
Once you have a tentative QPAI amount, the next step is to review the following rules.
W-2 Wage Limitation
The Section 199 deduction is limited to 50% of the taxpayer’s W-2 wages allocable to DPGR (qualified) activities. Thus, another step in the process is to determine your company’s wages allocable to the qualified activities to determine if the W-2 limitation applies. The incentive behind this provision is that Congress wanted to ensure that companies obtaining this deduction were creating or maintaining manufacturing jobs in the U.S. as gauged by wages paid to U.S. employees.
Taxable Income Limitation
Another potential limitation is that the Section 199 deduction is calculated by applying the percentage (currently 6%) to the lesser of QPAI or taxable income. Thus, a company with a net operating loss for the year cannot claim the manufacturing deduction, nor can the deduction be carried back or carried forward.
The Section 199 calculation and rules are quite complex including 200 plus pages of final regulations issued in 2006.
Contact us today to learn more about how we can assist in securing you Section 199 Deductions.