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199 Manufacturing Tax Deduction

The American Jobs Creation Act of 2004 provides for a deduction for certain domestic production activities under new IRC §199. The amount of the deduction is a phased-in percentage of the lesser of income from “qualified production activities” or taxable income. Although the benefits are modest in the early years, the deduction credit percentage will grow from 3% to 9% over the next 6 years.

Framework for Review

Because the benefit is new, limited guidance is available to taxpayers trying to navigate its key provisions. A&M’s tax professionals have spent significant time reviewing the available guidance and have developed a framework to help taxpayers work their way through the provisions.

• Analyze operations to segregate all significant revenue generation activities (including production, service and investment activities).
• Identify pools of costs related to all operations. Segregate the costs as direct, indirect or COGS.
• Investigate allocation methods currently applied within the business operations.
• Model various scenarios by segregating revenue and expenses by allocating to determine the appropriate cost allocations to determine the most effective method.
• Compute the projected benefit (federal and state).
• Suggest potential changes to maximize the benefit.

Complexities

Even though the law is new, the concept of statutory percentage deductions is not. Our experienced professionals understand how a law such as this, implemented in a vacuum, can have unintended and significant “down-side” consequences. While many commentators have focused on the obvious (e.g. What is production? What does “significant” mean?). We know to focus as well on the not so obvious (e.g. Will claiming this deduction for a construction activity require me to use PCM accounting?).