April 3, 2018
The U.S. corporate tax rate has historically been among the highest in the world. Years ago, Congress created the domestic production activities deduction (DPAD) primarily to help level the playing field between American manufacturers and foreign competitors that operate in countries with lower tax rates.
Prior to the Tax Jobs and Cuts Act (TCJA), C corporations and pass-through entities (including sole proprietorships, partnerships, limited liability companies treated as sole proprietorships and partnerships for tax purposes, and S corporations) were eligible for the DPAD. This tax break allowed businesses to claim a federal income tax deduction equal to a percentage of taxable income earned from eligible manufacturing and production activities conducted within the United States and Puerto Rico.
Although the TCJA lowered tax rates for many businesses, it wasn’t all good news: The new law also repealed the DPAD for tax years beginning in 2018 and beyond. So, the return for your business’s 2017 tax year may be your last chance to claim the DPAD. Here’s what you need to know to take advantage of this break before the chance to claim it expires.
Under Section 199 of the tax code, the DPAD is allowed for both regular tax and AMT purposes. It generally equals 9% of the lesser of:
1. Qualified production activities income (QPAI) for the year, which is defined as domestic production gross receipts (DPGR) minus cost of goods sold and other expenses allocable to DPGR, or
2. Taxable income for the year determined without counting the DPAD.
Domestic production gross receipts (DPGR) are gross receipts from the manufacture, production, growth or extraction of qualifying production property (QPP).
The DPAD rate is reduced to 6% for taxpayers with oil-related QPAI, which means income that is attributable to the production, transportation or distribution of oil and gas.
In addition, the DPAD write-off cannot exceed 50% of your business’s Form W-2 wages allocable to DPGR for the year.
Domestic production activities in Puerto Rico also qualify for the DPAD for the first 12 years of business for tax years beginning in 2006 through 2017.
Close-Up on DPGR
There are a lot of acronyms to keep straight when calculating the DPAD. But a critical one is domestic production gross receipts (DPGR) — it serves as the foundation for calculating income from qualified production activities.
Fortunately, the definition of DPGR is broad. It includes gross receipts from the lease, rental, license, sale, exchange or other disposition of the following:
Domestic tangible personal property. Specifically, this property must be manufactured, produced, grown or extracted by your business in whole (or significant part) in the United States. In 2007, the IRS ruled that a partnership engaged solely in the extraction and processing of minerals within the United States was eligible for the DPAD.
Examples of other qualifying tangible personal property include:
- Computer software,
- Sound recordings,
- Printing presses,
- Transportation equipment,
- Office equipment,
- Grocery counters,
- Testing equipment,
- Display racks and shelves, and
- Signs that are contained in or attached to a building.
Furthermore, machinery — other than structural components of a building — counts as qualifying tangible personal property. For example, gasoline pumps, hydraulic car lifts and automatic vending machines count as qualifying tangible personal property even if they’re attached to the ground. However, tangible personal property doesn’t include land, buildings, inherently permanent structures or land improvements.
Domestic film productions. To qualify as DPGR, at least 50% of the total compensation related to the production of the film is for specified production services (such as acting, directing or producing) performed in the United States.
Domestic production of electricity, natural gas or water. However, transmission or distribution of these commodities are specifically excluded from DPGR.
Domestic construction or substantial renovation of U.S. real property. This includes residential and commercial buildings and infrastructure, such as roads, power lines, water systems and communications facilities.
Domestic civil engineering and architectural services. These activities must be performed for construction projects in the United States.
Domestic farming. These activities include growing and selling agricultural products and food in the United States.
Domestic processing of agricultural products and food. This doesn’t include the sale of food and beverages prepared at a retail establishment.
Last Chance to Save
You might not have known about the DPAD or the broad range of business activities that can potentially qualify for this valuable tax break. But it’s not too late to claim your deduction for the tax year beginning in 2017.
Even if you’ve already filed your federal income tax return for the 2017 tax year or you realize that you missed the DPAD in returns for earlier years, you may be able to file amended returns and collect tax refunds. For more information on the DPAD, consult your tax advisor.