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Domestic Production Deduction FAQ

What is the Domestic Production Deduction?

• Part of the American Jobs Creation Act of 2004.
• An incentive to encourage manufacturing and other production activities in the U.S. using American employees.

What types of entities may qualify?

The domestic production deduction applies to all types of taxpaying entities, including:

• C corporations;
• S corporations;
• Partnerships;
• Sole proprietorships;
• Estates and trusts; and
• Co-ops.

When is the deduction effective?

• The domestic production deduction is effective for tax years beginning on or after Jan. 1, 2005. The IRS issued proposed regulations on Oct. 20, 2005.

Who qualifies?

The IRS has proposed an expansive definition of manufacturing, including items manufactured, produced, grown or extracted in the U.S. This definition encompasses contractors and subcontractors performing a wide range of construction activities. Thus, the domestic production deduction may apply to:

• Manufacturers;
• Construction companies, contractors and construction-related activities;
• Engineering and architectural firms (relating to construction);
• Software companies;
• Oil and gas companies;
• Food production for wholesale distribution;
• Media production companies;
• Installers and assemblers;
• Electric, gas and water companies—production but not transmission; and
• Agriculture-related activities and farmers.

What benefits does the deduction offer?

• A new deduction of up to 3% of qualified production activities income (QPAI) in tax years 2005 and 2006; and
• Deduction increases up to 9% in 2010 and later.

When is the deduction not available?

• When a qualifying entity does not have taxable income; or
• When a qualifying entity does not have domestic W-2 wages or leased employees.

How is the deduction calculated?

The domestic production deduction is based on the lesser of manufacturing income or taxable income. A qualifying entity must determine its gross receipts attributable to production of domestically produced tangible personal property. (Special rules apply to contractors, engineers and architects.)

From this amount, subtract:

1. Allocable cost of goods sold;
2. Allocable direct expenses; and
3. Allocable portion of indirect expenses.

Example:

Years	Potential Deduction	Taxable Income after Deduction	Income Tax	Savings
2005 and 2006	$30,000 (3% of $1,000,000)	$970,000	$339,500	$10,500
2007 through 2009	$60,000 (6% of $1,000000)	$940,000	$329,000	$21,000
2010 and after	$90,000 (9% of $1,000000)	$910,000	$318,500	$31,500

Questions on the domestic production deduction?
Contact Mike Calahan at 312-980-2886.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.