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Are you missing the manufacturing tax deduction?

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Have you failed to qualify for the Section 199 “manufacturing” deduction in the past? It’s worth a second look.

Initially, the Section 199 deduction was limited to 3% of the lesser of a taxpayer’s qualified production activity income (QPAI) or taxable income. The maximum deduction percentage was then doubled to 6%. It’s been increased to 9% for 2010 and thereafter.

QPAI is equal to domestic production gross receipts (DPGR) from qualified activities (see below) minus expenses. Expenses include the cost of goods sold allocable to the receipts, allocable direct and indirect costs and a ratable portion of other costs.

Production activities must be performed in whole, or in significant part, in the United States. The annual deduction is limited to 50% of related W-2 wages.

The Section 199 deduction can offset either regular income tax liability or the alternative minimum tax (AMT) for C corporations, individuals, farming cooperatives and estates and trusts. It may also be claimed by partners and owners of S corporations (but not the partnerships or the S corps themselves).

A business engaged in any of the following lines of business may qualify for the deduction:

  • Manufacture, production, growth or extraction of tangible personal property, computer software or sound recordings or qualified films
  • Production of electricity, natural gas or potable water in the United States
  • Construction services including related engineering and architectural services performed in the United States.

Within each of these categories, a broad range of types of activities are eligible. Raw materials and finished products may be new or made from scrap, salvage or junk material. Manufactured components can be used by another party in subsequent activities. Processing and preparing food products for sale at wholesale is an eligible activity, but preparation of food and beverages for sale at retail isn’t.