Companies claiming the “domestic production activities deduction” that is permitted under the tax code have some new guidance to consider as they determine where they might be eligible for the deduction.
The Internal Revenue Services has given its examiners some guidance internally meant to sharpen their focus on what activities are eligible for the “domestic production deduction” permitted under the tax code. The guidance is not a change in the law, and it’s not directed at taxpayers. However, it signals some criteria that taxpayers should keep in mind if they are claiming the deduction because it will be top of mind for examiners.
Under Section 199 of the Internal Revenue Code, taxpayers are allowed to claim the DPAD for income that comes from the manufacture, production, growth, or extraction of goods within the United States. That’s a broad generalization of the deduction. There are plenty of definitions and details in the rule to specify where the deduction applies, and where it does not.
The recent guidance from the IRS to its examiners is focused on the requirement in the tax code that a taxpayer demonstrate it has manufactured, grown, or extracted the qualified production property either wholly or in significant part within the United States. The IRS has identified some specific activities typically performed in retail settings that it considers outside the scope of the guidance, and therefore ineligible for the deduction.
Cutting blank keys or mixing paint to achieve a particular color, for example, do not quality for the deduction, the IRS say. Decorating a cake that is baked elsewhere also does not qualify. The IRS also determined some specific agricultural activities do not qualify, including applying agents to slow or expedite fruit ripening, storing agricultural products in a controlled environment to extend shelf life, or maintaining plants and seedlings.
The IRS directed its examiners to consider the specific facts and circumstances of a taxpayer’s activities, as well as the processes through which the activities are performed and the taxpayer’s industry sector in determining where the deduction is appropriate. The IRS also encouraged examiners to report other situations they encounter where activities are different but similar to those listed to help in further determination of which activities qualify and which do not.
The detailed guidance around whether an activity qualifies for the deduction is complex, making it tricky to determine in many cases. Sometimes it takes a determination by a court to settle differences between the IRS and taxpayers, as with a 2013 case involving a gift basket business. The IRS disallowed the deduction for a taxpayer who assembled and sold gift baskets, asserting the assembly amounted to only a service, not a qualified production activity. The taxpayer prevailed in challenging the IRS view.
If your business is involved in activity where the deduction might apply, a careful analysis is in order in light of the latest IRS guidance.