Internal Revenue Code Section 199 (Sec 199) was enacted to help offset the repeal of a tax break for U.S. exporters. Since 2004, Sec 199 has given U.S. manufacturers tax relief in the form of a deduction of a percentage of qualifying expenses. The deduction started at 4% for tax years 2004 – 2006, increased to 6% for tax years 2007 – 2009 and will be 9% for 2010 and all following years. In order to be eligible for the Sec 199 deduction, the taxpayer must have qualified production activities income (QPAI) which is domestic production gross revenue (DPGR) for the tax year minus costs of goods sold and other expenses or deductions allocable to those receipts.
DPGR includes the gross receipts of a taxpayer derived from any lease, rental, license, sale, exchange, or other disposition of qualifying production property (QPP). Common forms of QPP are:
- Manufacture, production, growth, or extraction of tangible personal property by the taxpayer in whole or in significant part in the U.S.
- Production of qualified films
- Production in the U.S. of electricity, natural gas, or portable water
- U.S. real property construction
- Performance in the U.S. of engineering or architectural services in connection with U.S. real property construction
The amount of the deduction for any tax year may not exceed the taxpayer’s taxable income or activities eligible for the deduction. Now that the deduction is fully phased in, the deduction is designed to be economically equivalent to a 3% reduction in the tax rate on eligible activities conducted in the U.S. The amount of the deduction is also limited to 50% of the taxpayer’s wages attributable to DPGR. Consequently, businesses that are sole proprietorships or partnerships with no employees are not eligible for the deduction.