One of the most popular tax deductions for manufacturers is no longer available. The Tax Cuts and Jobs Act repealed the Domestic Production Activity Deduction for years after 2017. However, other deductions, like accelerated depreciation for machinery and equipment, are still available.
It’s also important to note the corporate rate and flow through rates are going down for most businesses. For a C Corporation, the rate is 21% down from 35%. Owners of pass-through entities may now benefit from a 20% qualified business income deduction.
Under the new tax rates, manufacturers can use the additional capital to focus on growing and expanding their business through the hiring of new workers and purchasing equipment.
Is a significant portion of your profitable manufacturing business’ taxable income generated from production activities within the U.S.? If so, it may qualify for a deduction equal to 9% of its qualified production activity income (QPAI). The American Jobs Creation Act of 2004 included a tax relief provision for domestic manufacturers with the intent of stimulating manufacturing activity in the U.S.
As a safe harbor, the significance requirement can be met if the taxpayer’s direct labor and overhead for the qualified U.S. production is 20% or more of the taxpayer’s cost of goods sold. The computation can be ridiculously simple or quite complex, depending on the nature of the business, but understanding the technicalities of the calculations can often produce an even greater deduction than what may have been already claimed. What may seem simple on the surface can be quite complex in maximizing tax deductions.
If your business has claimed the Domestic Production Activity Deduction (DPAD or Section 199 Deduction), check the Form 8903 filed with your tax return. If the amount on line 10b is less than taxable income, there may be opportunities for more DPAD than claimed. Even if your business passes that simple test, there may be even more deductions lurking under the surface of the calculation itself.
With the DPAD at 9%, more businesses may find it worthwhile to recalculate and substantiate the deduction than in previous years when the percentage was lower. However, understanding the complex rules that govern the QPAI calculation is critical in maximizing available tax deductions. A simple first step is to determine if line 10b on Form 8903 is less than taxable income. If so, there are likely additional tax deductions available for all open tax years. Otherwise, there still may be more opportunities with an in-depth analysis of the QPAI computation. The statute of limitations for federal income tax returns is three years, so depending on when you filed your original tax returns, you may be able to amend years 2013 through 2015 in addition to an enhanced deduction for 2016.
If you are a partner or S-corporation shareholder in a manufacturing business and your Form K-1 does not show information for you to compute the DPAD on your personal tax return, there also may be an opportunity for the business to amend prior year returns to pass through the DPAD information to its owners.
Reviewing prior year tax returns for an additional DPAD could yield substantial savings. At 9%, a recalculated DPAD will yield about three cents of tax savings on every dollar of additional deduction found. There is very little risk in claiming the deduction since the amount is provided by statute. The key is in proper documentation and analysis with accurate computations supporting the deduction.
In addition, the DPAD applies to industries beyond manufacturing. It can apply to industries, including construction companies, software developers, engineering or architectural services related to U.S.-based projects, selling, leasing or licensing items that have been manufactured in the U.S. and the production of electricity, natural gas or water.
If you have questions about manufacturer tax issues, please contact Beth Van Leeuwen in our tax department at 816-743-7700.