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Focus on Manufacturing & Distribution: 199 Production Activities Deduction New Rules

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At this time, many of us have filed our 2005 tax returns reflecting the first year of the Production Activities Deduction. Legislative changes as well as additional regulations issued by Treasury have provided interesting guidance on the Production Activities Deduction. This e-focus article includes a description of some of these changes for manufacturers.
July 3, 2006

At this time, many of us have filed our 2005 tax returns reflecting the first year of the Production Activities Deduction. Legislative changes as well as additional regulations issued by Treasury have provided interesting guidance on the Production Activities Deduction. This e-focus article includes a description of some of these changes for manufacturers.

The following table summarizes the basic calculation:

Qualified Production Gross Receipts from ˜Manufacturing within the US'
-- Less Allocable Cost of Goods Sold
-- Less Allocable Selling, General and Administrative Expenses
= Equals Qualified Production Activities Income (QPAI)
Lesser of QPAI or Taxable Income
X Times Rate of Deduction (3% for 2005 “ 2006, 6% for 2007 “ 2009, 9% in 2010)
= Equals Preliminary Deduction
Lesser of Preliminary Deduction or 50% of W-2 wages
= Equals Domestic Manufacturing Deduction

  • Change to Wage Limitation “ The deduction is limited to 50 percent of wages. Originally, this deduction was W-2 wages of the entity. For tax years beginning after May 17, 2006 (the 2007 year for calendar year taxpayers), only wages related to the production activities will be included as W-2 wages for the 50 percent limitation.
  • Flow-Through Loss Carry-forwards prior to January 1, 2005 do not reduce Qualified Production Activities Income - If a partner or S corporation shareholder has suspended or at risk losses from a year prior to 2005 that are used to reduce allocable income in 2005 or after, these losses are not a reduction in qualified production activities income. This change may provide an amended return opportunity for some taxpayers who reduced their deduction on a 2005 return filed prior to this recent change in the regulations.
  • Relaxation of the Item-by-Item Requirement “ Final regulations clarify that activities must be considered on an item-by-item basis only in order to determine the gross receipts from qualified production activities. For computing the income from these activities, an item-by-item calculation is not required.
  • Embedded Services Exception Applies to Computer Maintenance Contracts “ Certain qualified services (warran- ties, delivery, installation and operating manuals) can be included in domestic production gross receipts if the price for the service is not stated or bargained for separately. Final regulations expand this exception to include Computer Software Maintenance contracts that meet these requirements.
  • Simplified Deduction Available to More Taxpayers “ The regulations require larger taxpayers to do more in-depth cost allocations in determining QPAI. Fortunately, for businesses with less than $100 million in receipts or $10 mil- lion in assets at year's end, the simplified deduction method is now available. Under the simplified method, costs of goods sold are specifically allocated to domestic production gross receipts. Selling, general and administrative costs are allocated based on the ratio of QPAI receipts to total gross receipts.

Other detailed changes may apply to your business. To understand further how to maximize your Production Activities benefit, contact Linda Paradis, 314.290.3382, or your RubinBrown partner.

 

Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.

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For more information, contact:

  • Linda Paradis, CPA — St. Louis
  • Partner
  • Tax Services Group
  • 314.290.3300
  • linda.paradis@rubinbrown.com