Understanding Section 199: Tax Law Area Application

Section 199 of the US tax code was part of the American Jobs Creation Act of 2004. It was repealed by the Tax Cuts and Jobs Act in 2017, but it allowed qualifying businesses to claim a tax deduction calculated as 9% of the lesser of their qualified production activities income or their taxable income. The deduction was also limited to 50% of the W-2 wages paid by the taxpayer that were allocable to domestic production gross receipts.

Section 199's application to the construction of real property

Section 199 of the US tax code applies to a range of domestic production activities, including the construction of real property. This section provides a valuable tax break for businesses engaged in construction, offering a deduction of up to 9% of income from qualified production activities.

To qualify for the deduction, construction activities must meet certain criteria. The construction must involve the erection or substantial renovation of real property, and the property must be considered an "inherently permanent structure". This means it should be affixed to real property and remain so for an indefinite period. Examples include residential or commercial buildings, permanent structures like docks and wharves, and infrastructure such as roads and power lines.

The taxpayer must also be engaged in the active conduct of a construction trade or business, and the gross receipts from the construction of real property must be derived from projects performed in the United States. Additionally, the taxpayer must own the property being constructed.

It is important to note that tangential services such as hauling trash and delivering materials do not qualify for the deduction, even if they are essential to the construction process. Decoration or redecoration of existing structures is also not considered eligible construction activity.

When calculating the Section 199 deduction for construction of real property, businesses should follow these steps:

• Identify areas of potential qualified production activities, including construction of real property.
• Calculate domestic production gross receipts (DPGR) and allocate them between qualified and non-qualified activities.
• Allocate cost of goods sold to DPGR.
• If necessary, determine, allocate, and apportion below-the-line expenses, such as charitable contributions, research and development expenses, and selling and administrative expenses.
• Calculate the deduction by multiplying the net taxable income of qualified products by the applicable percentage, which is currently 9%. The resulting deduction is further limited to 50% of Form W-2 wages allocable to DPGR.

By following these steps and carefully reviewing their construction activities and expenses, businesses can maximise their Section 199 deduction and take advantage of this valuable tax break.

Section 199's application to the production of electricity, natural gas, or water

In 2004, the American Jobs Creation Act introduced Section 199 to the Internal Revenue Code, creating a tax deduction for domestic production activities. This included the production of electricity, natural gas, and potable water.

Section 199 was designed to compensate for the repeal of the extraterritorial income (ETI) export-subsidy provisions, support the domestic manufacturing sector, and reduce effective corporate tax rates. The deduction was available to corporations, partnerships, and limited liability companies.

The deduction was calculated as 9% of the lesser of Qualified Production Activities Income (QPAI) for the taxable year, or 9% of taxable income for the taxable year. QPAI is defined as the taxpayer's Domestic Production Gross Receipts (DPGR) for the year, minus the costs of goods sold and expenses allocable to DPGR. DPGR refers to the gross receipts of a taxpayer derived from the lease, rental, license, sale, exchange, or other disposition of qualifying production property (QPP) that was manufactured, produced, grown, or extracted by the taxpayer within the United States.

In the context of electricity, natural gas, and potable water production, Section 199 applied to taxpayers with DPGR derived from the lease, rental, license, sale, exchange, or other disposition of electricity, natural gas, or potable water produced by the taxpayer in the United States. This meant that companies involved in the production of electricity, natural gas, or potable water could claim a tax deduction of 9% on their taxable income or QPAI, whichever was lesser.

The deduction was also limited to 50% of the W-2 wages paid by the taxpayer that were allocable to DPGR. This ensured that the deduction was linked to the wages paid for domestic production activities, benefiting companies that paid wages to domestic employees.

The application of Section 199 to electricity, natural gas, and potable water production provided a significant tax incentive for companies operating in these sectors. It reduced their effective tax rates, encouraging domestic production and investment in these industries.

Section 199's application to the production of qualified film

The Internal Revenue Service (IRS) has been involved in several disputes with taxpayers over the years regarding the application of Section 199 to the production of qualified films. Section 199 was enacted as part of the American Jobs Creation Act of 2004 to incentivize the creation of employment opportunities in domestic manufacturing and production activities. The amount of the Section 199 deduction is determined by applying 9% to the lesser of the taxpayer's qualified production activities income (QPAI) or taxable income. QPAI is calculated by subtracting the cost of goods sold and other expenses allocable to domestic production gross receipts (DPGR) from DPGR. DPGR includes the taxpayer's gross receipts derived from a list of qualifying activities, including the lease, rental, license, sale, exchange, or other disposition of any qualified film produced by the taxpayer.

A qualified film is defined as any motion picture or film under Section 168(f)(3), or live or delayed television programming, provided that at least 50% of the total compensation for the production is for services performed in the United States by actors, production personnel, directors, and producers. Additionally, a qualified film must be produced by the taxpayer, meaning they have the benefits and burdens of ownership over the film production activities. This can be determined through a facts and circumstances-based substantial in nature test or a quantitative safe harbor.

Determining whether an entire program package sold to customers can be treated as DPGR for purposes of computing the deduction has been a critical issue for taxpayers, particularly multichannel video programming distributors (MVPDs). The IRS has issued conflicting guidance on this issue, with some memoranda supporting the treatment of the entire programming package as a single qualified film, while others argue that only individual films within the package qualify. The IRS has also created a Large Business and International (LB&I) compliance campaign to address this issue, specifically targeting MVPDs and TV broadcasters that claim a group of channels or programs as qualified films.

Taxpayers claiming the Section 199 deduction for qualified film production face challenges due to the complexity of the rules and the IRS's scrutiny of certain claims. To mitigate potential issues, taxpayers should consider developing a pre-audit plan to address areas of high IRS scrutiny.

Section 199's application to the services of architecture/engineering

Section 199 of the Internal Revenue Code was enacted in 2004 to incentivize domestic manufacturing and production activities. The section allowed qualifying businesses to claim a tax deduction calculated as 9% of the lesser of qualified production activities income (QPAI) or the taxpayer's taxable income. This deduction was also limited to 50% of the W-2 wages paid by the taxpayer that were allocable to domestic production gross receipts (DPGR).

While the legislative history explains that the tax benefit was not available for revenue earned from services, there are exceptions for certain service sectors, including architecture and engineering. Specifically, the performance of engineering or architectural services in the US in connection with real property construction projects in the US is eligible for the Section 199 deduction.

The American Jobs Creation Act of 2004 defined "domestic production activities" expansively to include construction, architecture, and engineering. The Act also allowed companies to claim the deduction for products only partially produced in the US. According to a safe harbor in the regulations, if the manufacturing activities performed in the US account for 20% of the costs, the companies may be eligible for the manufacturing deduction.

The Section 199 deduction is allowed for the regular tax and the alternative minimum tax for individuals, C corporations, farming cooperatives, and estates, trusts, and their beneficiaries. The deduction is allowed to partners and the owners of S corporations but not to partnerships or the S corporations themselves.

The deduction is calculated as a percentage of the net income from eligible activities: 3% in 2005-2006, 6% in 2007-2009, and 9% after 2009. The amount of the deduction may not exceed the taxpayer's taxable income or, in the case of individuals, adjusted gross income. There is also a limitation of 50% of certain wages reported on Form W-2 that are attributable to domestic production.

The eligible categories of activities for the Section 199 deduction include:

• Manufacture, production, growth, or extraction (MPGE) of tangible personal property, in whole or in significant part within the US
• Construction of real property in the US
• Performance of engineering or architectural services in the US in connection with real property construction projects in the US

Eligible engineering services include consultation, investigation, evaluation, planning, design, and supervision of construction. Eligible architectural services include consultation, planning, aesthetic and structural design, and supervision of construction.

To claim the Section 199 deduction, taxpayers must:

• Identify areas of potential qualified production activities. Determine whether the manufacture, production of tangible personal property, and/or development of computer software occurred in the US. Then evaluate whether a product is held for sale, lease, or license or involves a hosting service.
• Calculate DPGR by allocating gross receipts between qualified and non-qualified production activities.
• Allocate the cost of goods sold to DPGR.
• If necessary, determine, allocate, and apportion below-the-line expenses.
• Calculate the deduction using sales and cost-of-sales data, and taxable income data. The net taxable income of the qualified products should be aggregated, and the lesser of QPAI or taxable income is then multiplied by the applicable percentage to determine the deduction, which is limited to 50% of Form W-2 wages allocable to DPGR.

Section 199's application to the manufacture, production, growth, or extraction of tangible personal property

The Section 199 deduction, also referred to as the domestic manufacturing deduction, U.S. production activities deduction, and domestic production deduction, was established by the American Jobs Creation Act of 2004 to ease the tax burden of domestic manufacturers and incentivise investment in domestic manufacturing facilities.

Section 199 applied to the manufacture, production, growth, or extraction of tangible personal property. This included all tangible personal property (except land and buildings), computer software, and sound recordings.

The manufacture, production, growth, or extraction of tangible personal property had to be conducted in whole or in significant part within the U.S. for the taxpayer to be eligible for the deduction.

The deduction was calculated as 9% of the lesser of the qualified production activity income or taxable income for the year. This was then further limited to 50% of Form W-2 wages allocable to domestic production gross receipts (DPGR).

DPGR was calculated as the gross receipts of the taxpayer derived from the lease, rental, license, sale, exchange, or other disposition of qualifying production property, which was manufactured, produced, grown, or extracted by the taxpayer.

The Section 199 deduction was allowed for both regular and alternative minimum tax for individuals, C corporations, farming cooperatives, estates, trusts, and their beneficiaries. It was also allowed at the partner, member, and owner level for a partnership, LLC, and S corporations, respectively.

Frequently asked questions