The Section 199 tax deduction was first introduced with the American Jobs Creation Act of 2004. It was intended to primarily benefit America's manufacturing industry. Indeed, sometimes the tax beak is called the "manufacturers' deduction" or the "domestic production activities deduction." But, helpfully, eligibility for the break is broad enough to include many other types of businesses.
Among the primary requirements for the deduction is that your company regularly perform “qualified production activities.” These are generally defined as tasks related to manufacturing, producing, constructing, growing or extracting property “in significant part” within the United States. If any of that sounds familiar, it may be time for you to check out Sec. 199.
Identifying and gathering
To get started, you’ll need to identify and document your qualified production activities, and then determine how much income you’ve derived from them. Doing so will require gathering gross receipts from the lease, rental, exchange or other transfer of qualifying production property minus out-of-pocket expenses, such as materials costs. Eligible items include tangible personal property, computer software and sound recordings used in qualified production activities.
Having done all of this, you may then be able to claim a deduction equal to 9% of the lesser of either your net income derived from your qualified production activities or your entire taxable income for the year. There is, however, an important caveat: The deduction can’t exceed 50% of the W-2 wages paid to employees during the calendar year that are allocable to domestic production gross receipts.
Crunching the numbers
Let’s take a hypothetical look at the Sec. 199 deduction and how it might benefit a business. Say your company nets $800,000 in taxable income on $4 million in gross receipts in 2016, entirely from qualified production activities. Assuming your W-2 wages paid are adequately substantial, the deduction at the 9% rate will be $72,000, for a federal tax savings of over $25,000 based on a 35% rate. That would presumably be a nice cash flow boost.
Perhaps the biggest challenge of the Sec. 199 deduction, and one that many companies underestimate, is the administrative burden that may be associated with claiming it. You’ll need to meticulously track and maintain documentation for your business’s qualifying production activities.
Getting everything in order
If you’re intrigued by the Sec. 199 deduction, please call us. Not only are the administrative requirements challenging, but the calculations involved often get complex as well.