Section 199 is new and complex. Realizing the full benefit of the deduction can require complex analyses and calculations. However, the benefits can be significant.
What is the Section 199 deduction? If you produce goods, develop software or construct property in the U.S., regardless of whether they are exported, Congress has provided you the means to significantly reduce your tax bill. Created as the centerpiece of the American Jobs Creation Act, the new domestic production activities deduction is estimated to result in over $76 billion dollars of taxpayer savings over a ten-year period.
How does the deduction work? The deduction is permanent in nature and is equal to a percentage of the lesser of your taxable income or net income earned from qualified production activities. It is available for tax years beginning after Dec. 31, 2004. The deduction will be three percent for tax years 2005 and 2006; six percent for tax years 2007, 2008 and 2009; and nine percent for tax years 2010 or later.
What activities qualify? Qualified domestic production activities include:
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Manufacture, production, growth or extraction of tangible personal property, computer software or sound recordings or qualified films
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Production of electricity, natural gas or potable water in the U.S.
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Construction services including related engineering and architectural services performed in the U.S.
How is Qualified Production Activities Income calculated? Domestic Production Gross Receipts minus expenses equal Qualified Production Activities Income (QPAI). Expenses include the cost of goods sold allocable to the receipts, allocable direct and indirect costs, and a ratable portion of other costs.
What's so complex about it? There are a number of interlinking issues that come into play when calculating the most advantageous Section 199 deduction. Ask yourself the following questions:
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How did you define your revenue streams?
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Do you have a full understanding of the relevant section 861 regulations; and can you demonstrate how you maximized them?
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Which of the three W-2 limitations is most beneficial?
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What impact does the expanded affiliated group definition have on your calculation?
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What state planning activities need to be re-evaluated after completing your section 199 computation?
What tools should I use to calculate the section 199 deduction? Using an existing software tool, originally built to serve a different purpose, will not likely result in the optimal benefit for your facts and circumstances. Furthermore, a software tool alone cannot be relied upon to replace the judgment of a seasoned tax expert in determining the appropriate calculation.
Our three-phase approach Grant Thornton takes a three-phase approach in which we work with you to fully understand your business. We analyze all the revenue streams associated with all your entities and go through the appropriate expense allocations. Our analysis and work plans are driven by your facts and circumstances. Our new software is a powerful modeling tool, but our approach is not to let our software do all the work. Our team applies their expertise and uses the tool to help you model, calculate, document and support your deduction.
Contact one of our regional tax partners:
Mark Andrus | Partner, West Region | 503.276.5910
Joe Brown | Partner, Midwest Region | 312.602.8580
Jon Rausch | Managing Director, Central Region | 832.476.5020
Peter Colley | Partner, Southeast Region | 404.475.0050
Jim Wittmer | Partner, Northeast Region | 215.656.3065
