Learn how to claim a larger tax deduction on your tax return.
If you or your company claims the domestic production activities deduction (DPAD) (sometimes called the production deduction, manufacturing deduction or 199 deduction) you may not be getting the most benefit available to you. Many tax preparers do not realize that taxpayers are provided as many as four different options for computing the DPAD. Many times only one method is considered when tax returns are completed. The DPAD is 9% of qualified production activities income (QPAI). QPAI is a calculation of a taxpayer's total domestic production gross receipts (DPGR) less total allocable expenditures. An opportunity arises as taxpayers are responsible for determining the portion of their total expenditures that are allocable to domestic production gross receipts (DPGR). How the expense allocation is determined can greatly change the calculation of QPAI and thus the size of the allowable deduction.
The four different methods are provided for in the regulations under the code sections 1.199-4(d), (e), (f) and section 1.199-1(d)(3). These methods are known as the 861 Method, the Simplified Deduction Method, the Small Business Simplified Overall Method, and the Safe Harbor Method or De Minimis Method. Not all taxpayers will be eligible to use all methods in a particular year and the methods available can change from year-to-year. Therefore, each year all four methods should be analyzed to determine which methods are available in the particular year and which allowable method which provides the greatest deduction. Just because a particular method was the most beneficial one year does not mean it will provide the largest deduction in the next.
861 Method (Section 1.199-4(d))
In general, all taxpayers must use the 861 Method unless they are eligible to use one of the other methods provided for by the regulations. Generally, the 861 Method requires that a taxpayer specifically identify the cost of goods sold (CGS) and the other deductions allocable to DPGR. There are additional rules under section 861 which must be followed when using the 861 Method. These rules are complicated and taxpayer's should consult a tax advisor for guidance.
Simplified Deduction Method (Section 1.199-4(e))
A taxpayer that has average annual gross receipts of $100,000,000 or less or that has total assets of $10,000,000 or less is eligible to use the simplified deduction method. For individuals who receive one or more schedule K-1s this determination is completed at the individual level.
Under this simplified method eligible taxpayers are allowed to apportion deductions between DPGR and non-DPGR. Qualified deductions are ratably apportioned between DPGR and non-DPGR based on relative gross receipts. The simplified deduction method does not apply to CGS which are allocated using methods similar to those under the 861 Method.
Small Business Simplified Overall Method (Section 1.199-4(f))
Taxpayers that are allowed to use the cash method of accounting and that have average annual gross receipts of $10,000,000 or less are eligible to use the small business simplified overall method. Also all taxpayers that have average annual gross receipts of $5,000,000 or less are eligible to use the small business simplified overall method. Certain other taxpayer may also be allowed use of this method, contact your tax advisor to see if you are eligible. As with the simplified deduction method, the determination of whether an individual can use the Small Business Simplified Overall Method is made at the individual level.
The Small Business Simplified Overall Method allows eligible taxpayers to ratably apportion both CGS and other deductions between DPGR and non-DPGR based on relative gross receipts. In certain situations this allows taxpayers to allocate CGS away from DPGR thus increasing their QPAI and the ultimate deduction claimed.
A taxpayer eligible to use the small business simplified overall method may choose at any time for any taxable year to use the small business simplified overall method, the simplified deduction method or the section 861 method for a taxable year.
Safe Harbor De Minimis Calculation (Section 1.199-1)
If less than 5% of the taxpayer's total gross receipts are non-DPGR then all of the taxpayer's gross receipts may be treated as DPGR. Reg. Sect. 1-199-1 provides that the 5% test is to be made at the corporation level, partnership level and individual level. Thus, in the case of an owner of a pass-through entity, the determination of whether less than 5% of the owner's total gross receipts are non-DPGR is made at the owner level, taking onto account all gross receipts of the owner from its other trade or business activities and the owner's share of the gross receipts of the pass-through entity.
The de minimis calculation can be a valuable tool for those taxpayers who have QPAI and also have income from non-qualifying activities that does not exceed 5% of their allocated DPGR.
This 5% safe harbor calculation also works the opposite way and all of the taxpayer's gross receipts may be treated as non-DPGR if less than 5% of the taxpayer's total gross receipts are DPGR. This can also be a valuable tool for those taxpayer's who have minimal DPGR and negative QPAI. If the taxpayer is claiming the DPAD deduction any negative QPAI allocation can reduce the allowable deduction.
Special rules apply to expanded affiliated groups (EAG), consolidated groups, oil and gas related production, production in Puerto Rico, and domestic production related to film and television. These rules are beyond the scope of this narrative and taxpayer?s involved with these activities should consult their tax advisor for correct application of these rules.
How to start claiming a larger deduction today
If you or your company is currently claiming the DPAD deduction make sure that your tax preparer is evaluating all available methods when calculating the deduction. If you believe that you are eligible to claim a DPAD deduction and it is not yet included on your return consult your tax advisor. For a free independent review of your situation please contact me today. I can review the deduction you are claiming and ensure that you are realizing the most benefit. If you are qualified to claim a deduction and are not yet claiming the DPAD deduction I can assist you in claiming the deduction and possibly claim deductions for prior tax years.