Section 199: Benefiting From the Production Activities Deduction

Overview

Course Objectives

• Understand what activities qualify for the Section 199 deduction.
• Understand the rules related to tax ownership, contract manufacturing, and other hot topics.
• Understand how to identify the system changes that will be needed to compute the information to compute the deduction.
• Understand how to perform allocations of income and expense.
• Understand rules related to NOLs, the W-2 wage limitation, pass-through entities, and related parties.
• Assist your employer or clients with tax planning through the use of the deduction for income attributable to domestic production activities.

Introduction

The Internal Revenue Code Section 199 tax break for domestic producers in the American Jobs Creation Act of 2004 has been estimated to be worth $76 billion over the next 10 years - a phased-in deduction of 3% in 2005 and 2006, 6% from 2007 through 2009, and 9% in 2010 and thereafter. It will have an impact on a wide range of businesses, including U.S. manufacturing, production, growth, or extraction of tangible personal property, software development, and music recording; U.S. production of movies, television, and video; U.S. production of electricity, natural gas, and water; U.S. construction or substantial renovation of real property; and U.S. performance of engineering and architectural services.

On February 14, 2005, the IRS issued Notice 2005-14 to provide guidance on many aspects of Section 199.

On October 20, 2005, the Treasury issued Proposed Regulations under Section 199.

The Gulf Opportunity Zone Act of 2005, enacted into law on December 21, 2005, includes Technical Corrections to Section 199.

The Technical Correction changes are understood to be incorporated in the Proposed Regulations.

Course Components

The complete video-based course consists of:

• A manual of eight chapters
• A video presentation of eight segments
• An examination for self-study credit
• An exam answer form, and
• A course evaluation form

Course Organization

This course is organized as follows.

• Segment and Chapter 1, Overview of the Section 199 Deduction
• Segment and Chapter 2, Definition of an "Item"
• Segment and Chapter 3, Domestic Production Gross Receipts
• Segment and Chapter 4, Domestic Production Gross Receipts (Continued)
• Segment and Chapter 5, Construction, Engineering, and Architectural Services
• Segment and Chapter 6, Expanded Affiliated Groups and Pass-Through Entities
• Segment and Chapter 7, Allocation of Costs
• Segment and Chapter 8, Limitations on the Section 199 Deduction and the Alternative Minimum Tax

Chapter 1

Overview of the Section 199 Deduction

Learning Objectives

After completing this chapter, you should be able to explain:

• The mechanics of the Section 199 computation
• Practical concerns in applying Section 199
• The administrative guidance in effect

Introduction

This chapter provides a brief overview of Section 199. Later chapters will build on this foundation.

Section 199 provides a deduction for income attributable to domestic production activities, and is colloquially referred to as the “production deduction.” Section 199 generally provides a deduction equal to a percentage of income arising from certain production activities and applies in different manners to different industries and transactions.

The Proposed Regulations under Section 199 are complex and contain a number of nuances of critical importance.

Background

The American Jobs Creation Act of 2004 enacted on October 22, 2004 contemporaneously repealed the exclusion for extraterritorial income (the ETI regime) and created the Section 199 deduction. The ETI rules, in part, excluded extraterritorial income from the income of a United States manufacturer that exported those manufactured goods. The World Trade Organization (WTO) ruled that, like the preceding Foreign Sales Corporation (the FSC regime), the ETI rules were an illegal export subsidy that violated international trade agreements.

Faced with increasing European Union sanctions, Congress repealed the ETI rules. Concerned, however, that the repeal of ETI would adversely affect U.S. manufacturers, Congress created Section 199 to provide a new benefit to U.S. manufacturers.

Section 199 not only benefits many exporting companies that had benefited from the ETI regime, it also benefits many non-exporting companies that had not benefited from the regime. Because Section 199 applies whether or not a company exports, it is not an export subsidy and therefore is WTO-compliant.

Computing the Amount of the Section 199 Deduction

In General

Section 199 provides a deduction in the amount of a percentage of the lesser of Qualified Production Activities Income (QPAI) or taxable Income. QPAI also is referred to as “qualified income.”

The deduction is phased in as ETI benefits phase out. For tax years beginning in 2005 and 2006, the deduction is equal to 3% of a taxpayer’s income from domestic production activities. The percentage increases to 6% for years beginning in 2007 through 2009, and reaches 9% for tax years beginning in 2010 and thereafter.

Amount of the Deduction

When fully implemented, the 9% deduction will be equivalent to a rate reduction for corporate taxpayers in the maximum 35% marginal tax bracket of 3.15 percentage points on their income from domestic production activities.