Section 199 of the tax code makes a tax deduction available to U.S. businesses that engage in “qualified domestic production activities” — and it’s not limited to manufacturers. Construction contractors, architects, engineers, software developers and others also may qualify.

A Potentially Valuable Deduction

The deduction equals 9% of the lesser of a business’s qualified production activities income (QPAI) or taxable income, but limited to 50% of the company’s W-2 wages attributable to qualified production activities.

How valuable can the deduction be? Let’s say a company earns $400,000 in taxable income on $2 million in gross receipts, all of it from qualified production activities. Assuming the company’s W-2 wages are high enough, the deduction would be $36,000, for federal tax savings of $12,240.

This assumes that the company is taxed as a C corporation. The savings could be even higher if your company is taxed as an S corporation or limited liability company (LLC), in which case the savings “pass through” to the owners of the company.

The manufacturers’ deduction generally can’t reduce net income below zero to create a net operating loss. But it can be used against the alternative minimum tax.

Who Can Qualify

You may qualify for the manufacturers’ deduction if your business derives revenue from:

• Manufacturing, producing, growing or extracting “qualifying production property” — including goods, agricultural products, oil and gas, computer software, and sound recordings — in whole or in significant part within the United States,
• Producing films that meet certain domestic requirements,
• Producing domestic electricity, natural gas or potable water,
• Performing construction in the United States, or
• Performing architectural or engineering services in the United States for domestic construction projects.

Sec. 199 doesn’t define “in significant part.” Fortunately, the regulations do provide a safe harbor: A business can automatically satisfy the in-significant-part test if its U.S. labor and overhead costs make up at least 20% of the property’s cost of goods sold.

Also keep in mind that, even if a business doesn’t meet the test for a particular product, it may be able to claim the manufacturers’ deduction for a product component that’s produced in significant part in the United States.

Can Your Company Benefit?

If you think you might qualify for the manufacturers’ deduction, contact us. Calculating your QPAI can be complicated, and we can help.