Publications
Design Professional's Practice Bulletin
Volume 10, Number 1 - November 2005
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This Bulletin addresses recent developments affecting Design Professionals as well as business concerns as important as the specific professional and technical issues they face.
Court Finds That Standard AIA Contractual Limitations Period Waives Governmental Immunity To Statutes of Limitation
Editors: Neil P. Clain and Richard J. Davies
Professional Service Firms Should Not Overlook Domestic Production Activity Deduction By Dirk Simpson, Esquire
By Dirk M. Simpson, Esquire
With the end of the year present, and tax time looming, it may be worthwhile to consult with your tax advisor about the applicability and feasibility of claiming the relatively new, and potentially valuable, domestic production activity deduction under Internal Revenue Code Section 199.
The calculations and recordkeeping required to claim the deduction can be complex, and the benefits usually do not outweigh the administrative burdens for small companies entitled to claim the deduction. Nevertheless, experts still believe the deduction offers significant tax opportunities for eligible midsized companies. The deduction is summarized below.
Section 199 allows a deduction equal to a specified percentage (it increases from 3% in 2006 to 9% in 2010) of the lesser of something called "qualified production activities income of the taxpayer for the taxable year" or taxable income for the taxable year. The second element can be ignored, as it is designed to prevent the deduction from generating a negative taxable income. The deduction, which is limited to 50 percent of a company's W-2 wages paid, is available to qualifying C corporations, S corporations, partnerships, sole proprietorships, estates and trusts.
Unfortunately, determining what is "qualified production activities income" or QPAI as it has come to be known can be difficult. The statute provides that it equals any excess of the taxpayer's "domestic production gross receipts" for the taxable year, over the sum of the cost of goods sold allocable to those receipts, other deductions, expenses, or losses directly allocable to those receipts, and a ratable portion of other deductions, expenses, and losses not directly allocable to those receipts or to another class of income. If you are still processing that last sentence, the point to be taken is that you must focus on "domestic production gross receipts" or, to use the rapidly emerging acronym, DPGR.
The deduction, which is limited to 50 percent of a company's W-2 wages paid, is available to qualifying C corporations, S corporations, partnerships, sole proprietorships, estates and trusts.
PGR are the gross receipts derived from the production of personal property in the United States (this deduction was designed to reward United States manufacturers), but it also includes gross receipts collected by service firms that:
- Provide engineering and architectural services performed in the United States.
- Engage in substantial renovation of real property or infrastructure, such as residential and commercial buildings, roads, power lines, water systems, and communications within the United States.
Recent Treasury regulations clarify that taxpayers wishing to qualify for the deduction must generate DPGR from regular activities defined as construction by the North American Industry Classification System.
Additionally, architectural or engineering services must be performed in connection with the construction of real property within the United States. Income from land sales or leasing does not qualify as construction for the purposes of determining gross receipts. However, the regulations offer a safe harbor for determining the value of land, which should greatly reduce allocation concerns.
We recognize that all of this may appear technically overwhelming, but that impression should not keep you from seeking professional counsel to explore the potential from this deduction. We will happily assist you in the effort.
