Domestic Manufacturing Deductions & Tax Credit Guide
The American Jobs Creation Act of 2004 (AJCA) is a great way for small businesses to stay afloat and create jobs. This legislation includes many helpful tax credits, such as Section 199 or domestic manufacturing tax credit, which allows domestic manufacturing and production businesses to reduce the federal tax rate from 35% to 31.85%. This law is also known as domestic production activities deduction (DPAD) or Domestic Manufacturing Deductions.
It was put into effect in 2005 to give a tax break for businesses that hire employees and produce goods or engage in other manufacturing within the United States, rather than outsourcing work overseas. Certain ‘domestic production activities’ are mandatory to qualify for this domestic manufacturing deduction.
Which Type Of Companies Are Eligible For Domestic Manufacturing Deduction?
Production and manufacturing activities are related to several entities function across multiple industries like the following ones:
- Agricultural products handling
- Portable water production
- Sound recording
- Gas and water
- Film production
This domestic manufacturing tax credit is available for limited liability companies, partnerships, and C & S corporations.
How To Determine If Your Business Can Qualify For Domestic Manufacturing Tax Credit?
It is mandatory for a taxpayer to have domestic production gross receipts (“DPGR”) pertaining to one or more of the following eligible activities (also known as domestic production activities):
- Architectural or engineering services performed in the United States for the US-based construction projects
- Portable water, natural gas, or electricity produced in the US
- Construction work done in the US. This includes both renovations of existing buildings and constructing new buildings. Note that rental income through real properties is not applicable for domestic manufacturing deduction
- Videos or films with at least 50% of video production done in the US (sexually explicit films and videos are not eligible for this benefit)
- Any exchange, license, rental, lease, sale, or other disposition of sound recording, computer software, or tangible property that you grew, produced, manufactured, extracted, in whole or in the form of ‘significant part’, within the US
The tangible personal property category is the most inclusive of all. The IRS has rules for how much of your business can be intangible. So if you produce any tangible personal property in significant part and then dispose of it by sale or otherwise, there may be an opportunity to take advantage of domestic manufacturing deductions. The IRS has a very clear definition for what it means to be a “significant part” of a property (IRS Notice 2005-14). The labor and overhead incurred on the property can’t be less than 20% of the total cost.
The tangible personal property in the United States can be anything other than tangible properties like buildings, lands, and other structural components of buildings. Below listed are some of the most common examples of tangible personal property:
- Automatic vending machines
- Hydraulic car lifts
- Neon or other signs
- Display shelves and racks
- Testing equipment
- Transportation equipment
- Office equipment
- Production machinery
- Printing presses
If you are engaged in any business that involves manufacturing, producing, or growing tangible personal property then this deduction is available to you. The definition of “manufacturer” includes almost every type of activity related to creating physical goods including making new material from scratch and assembling two different articles together as well.
Let’s see an example. If Alan owns a crafts business and he has 4 employees working for him. He purchases leather and his employees make belts out of it. Now, these belts are tangible property produced in a certain part of the US. As a result, Alan’s activity is eligible for a domestic manufacturing deduction.
Deductions and Tax Deduction Amounts
The Domestic manufacturing Deduction is an important incentive for businesses that want to increase production and employment in America. The maximum credit you can claim under this deduction amounts to up to 9% of your income from the business, but only if it has employees.
In addition, it has two significant limitations:
- The deduction cannot be more than your company’s taxable income
- Maximum half of the amount you spend on your workers who engage in domestic manufacturing/production is deductible
The deduction is limited to the adjusted gross income if you run LLC or partnership, S corporation, or sole proprietorship.
Is the Domestic Production Activities Deduction Available for 2022?
The Domestic Production Activities Deduction has been eliminated under a new tax package passed at the end of 2017. This means taxpayers other than C corporations can no longer be able to deduct their domestic-based spending.
The Section 199A deduction, also known as the qualified business income deduction has been created to replace domestic production activities. The new law applies only for owners of S corporations, sole proprietorships, and partnerships in addition to manufacturing companies that produce goods domestically within U.S borders.
Get Help from Professionals
The domestic manufacturing tax credit is an excellent way to save dollars for your business. If you aren’t considering that, you are missing out on a lot of money as a manufacturing enterprise.
You can count on us to handle your needs related to domestic manufacturing deductions and other incentives like research and development tax credits. Book your call today and our executive will get back to you within 1-2 days.