Do you qualify for a higher manufacturing deduction in 2010?

BY JAMES J. BAILEY JR., CPA, MST, CFP®

Despite its nickname, the so-called “manufacturing deduction” is not necessarily limited to traditional manufacturing companies, although those firms are certainly eligible for the write-off. It is available to more businesses than you may think. If your company qualifies, it can claim a new “high point” deduction for 2010.

Under Section 199 of the tax code, a business can currently deduct 9 percent of the lesser of its qualified production activity income (QPAI) or its taxable income. The maximum Section 199 deduction, established by the American Jobs Creation Act of 2004, was initially increased from 3 percent to 6 percent before reaching the top 9 percent figure for 2010. For a corporation in the top 34 percent bracket, the deduction is effectively equal to a tax cut of approximately 3 percent.

The QPAI is equal to domestic production gross receipts from qualified activities less expenses. Expenses include the cost of goods sold allocable to the receipts, allocable direct and indirect costs and a ratable portion of other costs.

The production activities must be performed, at least in significant part, in the United States. The annual manufacturing deduction is limited to 50 percent of the W-2 wages. The deduction can be claimed by any business entity – such as C corporations, S corporations, limited liability companies, partnerships and sole proprietors – as well as estates and trusts.

Besides traditional manufacturers of goods, this tax break also applies to farmers, fishermen, miners and construction businesses. Recent IRS regulations have focused on special treatment in the construction field. For instance, a qualified company does not actually have to construct buildings. The deduction may be extended to certain taxpayers in the business of painting, drywalling and landscaping.

Similarly, the deduction is generally available to engineers and architects. As long as the services are related to construction, the costs may qualify, even if no actual construction takes place. The deduction may also be claimed by businesses conducting feasibility and environmental impact studies.

Under a safe-harbor rule, a business entity can take the deduction if at least 20 percent of the total costs are the result of direct labor and overhead costs from U.S.-based operations. If any part of the production activities come from outside the United States, the business must use either the safe-harbor rule (at least 20 percent of total costs are from U.S.-based production activities) or allocate costs using the particular facts and circumstances.

Consult with your professional tax adviser to determine if your business qualifies for the higher 9 percent manufacturing deduction in 2010.

James J. Bailey Jr., CPA , MST , CFP®, is a Principal and Director of Tax Services for Needel, Welch & Stone P.C. He can be reached at (781) 982-1001 or jbailey@nwscpas.com.


Published in Cape & Plymouth Business August 2010