January 13, 2006 12:56 am
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By John Stambaugh
Commentary
People sometimes complain their tax adviser speaks another language. Chances are you are about to hear a new “foreign” term from your tax adviser: the Domestic Production Activities Deduction. But those who can “translate” may be able to save tax dollars.
The American Jobs Creation Act of 2004 put in a place a new deduction for certain taxpayers, the Domestic Production Activities Deduction. I call it the Section 199 deduction. For 2005 and 2006 it is, generally, equal to 3 percent of the lesser of: (1) the qualified production activities income or (2) taxable income for the taxable year. The deduction cannot exceed 50 percent of the W-2 wages paid by the taxpayer during the tax year. In addition, if the business is a sole proprietorship, the “taxable income” limit is replaced with the taxpayer’s adjusted gross income.
This is typical circular tax-law language. Let me try to put it in plain terms. Generally, if you qualify, you may get a deduction for up to 3 percent of your business net income. For example, if your business netted $50,000 for the year, your Section 199 deduction would be $1,500. So, your net taxable business income would be $48,500. This assumes you pay the necessary W-2 wages. Again, this is a very broad generalization. Consult your tax adviser for how this applies to you.
Who qualifies?
Here is brief summary of what kind of business qualifies, (for the complete list consult your tax adviser):
1. U.S. manufacture, production, growth or extraction, in whole or significant part, of tangible personal property, software development or sound recordings.
2. Any qualified film produced by the taxpayer.
3. U.S. production of electricity, natural gas or potable water.
4. Construction or substantial renovation of real property, including residential and commercial building.
5. Engineering and architectural services performed relating to construction of U.S. real property.
Before you conclude your business doesn’t qualify, let me give you some broad examples of the kinds of businesses that may, in part or in whole, qualify for the Section 199 deduction: manufacturers of almost anything, wholesale food processors, farmers, commercial or residential builders, painting as part of construction and wineries.
Here are some businesses that generally won’t qualify: the service professions (doctor, lawyer, dentist, stock broker, and accountants but note that engineering and architectural businesses can qualify), retailers, residential or commercial landlords and restaurants.
Phantom deduction
Just to be clear you won’t write a check to get the deduction, it is a non-cash deduction like depreciation. You compute it and deduct it on Form 8903.
The 3 percent deduction increases to 6 percent for 2007, 2008 and 2009. It then increases to 9 percent after 2009. So this is a very substantial deduction.
For those who qualify the Section 199 deduction can save tax dollars. It is just a matter of getting the proper information and spending the necessary time to correctly compute the deduction to get the maximum benefit.
Stambaugh is a local certified public accountant with more than 18 years experience in business tax planning and tax preparation and a master’s degree. He can be reached at 234-2438.
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John Stambaugh / commentary