Domestic Production Activities Deduction

Taxpayers can take a deduction for a percentage of their income attributable to certain production activities that take place within the United States (i.e., domestic production activities). The domestic production activities deduction is equal to 9 percent of the lesser of the taxpayer's qualified production activities income (QPAI) or its taxable income. However, the amount of the deduction is limited to 50 percent of the W-2 wages paid by the taxpayer that were allocable to the taxpayer's domestic production gross receipts.

Your QPAI is equal to domestic production gross receipts (DPGR) less certain expenses, losses, or deductions allocable to that DPGR. In determining your DPGR, you must first determine the total amount of gross receipts. Gross receipts include total sales (net of returns and allowances), amounts received for services provided as part of a trade or business, and income from incidental or outside sources (such as investment income). The amounts subtracted from DPGR include the cost of goods sold allocable to DPGR and any other expenses, losses, or deductions that are properly allocable to DPGR.

The following activities generate DPGR:

1. the construction of real property in the United States by a construction trade or business;
2. the performance of engineering or architectural services in the United States by an engineering or architectural services trade or business for the construction of real property in the United States; and
3. any lease, rental, license, sale, exchange, or other disposition of (a) qualifying production property manufactured, produced, grown, or extracted in whole or significant part within the United States; (b) a qualified film for which more than 50 percent of the total compensation required to produce the film is paid for services performed in the United States; and (c) certain utilities (electricity, natural gas, and potable water) produced in the United States.

For purposes of determining what DPGR is "derived from the lease, rental, license, sale, exchange, or other disposition," the IRS looks to gross receipts directly derived from the lease, rental, license, sale, exchange, or other disposition of qualified production property (QPP), a qualified film, or utilities.

Whether you are in a position to take advantage of this deduction depends on several things.

First, the domestic production activities deduction generally is equal to 9 percent of the lesser of your qualified production activities income or your taxable income. Thus, if you do not have taxable income, there is no deduction. For purposes of this computation, the taxable income of individuals, estates, and trusts is their adjusted gross income. All other taxpayers use their actual taxable income in this computation. In either case, taxable income is determined without taking into account the domestic production activities deduction itself.

Second, the amount of the domestic production activities deduction is limited to 50 percent of the W-2 wages you have paid that are properly allocable to its domestic production gross receipts. Thus, if you have no such W-2 wages, there is no deduction.

The rules for taking this deduction are quite complicated. If you feel you might be eligible for this deduction, please give me a call so we can set up an appointment to discuss your situation.