Domestic Production Deduction

The domestic production deduction was created to encourage manufacturing and production within the U.S., and at times is confusing, but it provides a beneficial business deduction equal to 9% of the lesser of net income from qualified production activities or 50% of the W-2 wages paid to employees properly allocated to the domestic production activity.

Thus, it represents a sizeable business deduction that can have a substantial impact on your tax bottom line.

In published guidance, the IRS reversed earlier positions, now allowing:

- Gross receipts from providing software for a customers' direct use while connected to the Internet to be treated as derived from a qualifying disposition.

- Gross receipts derived from materials and supplies consumed in a construction project to be included in domestic production gross receipts from the construction of real property.

Generally, the deduction is allowed to all taxpayers, including individuals, corporations, farm cooperatives, estates and trusts. The deduction is passed through to owners of partnerships, S-corporations and cooperatives, allowing them to deduct it on their own returns.

The following is an example of how this deduction works. Suppose your business manufactures a product that you wholesale to retailers. Your net income from sales of that product for the year is $800,000, and the wages you paid your employees to manufacture that product totaled $100,000. Your deduction would be the lesser of 9% of the $800,000 in revenue, which would be $72,000, or 50% of the $100,000 wages. Thus, your business domestic production activities deduction would be $50,000 (50% of $100,000).

The IRS guidance also provides simplified methods of determining the deduction. If you need assistance in setting up your accounting to accommodate this deduction, please give this office a call.