Can I Qualify for Greater Manufacturing Tax Deductions?
How Evolving Regulations can Benefit You
Have you been wondering if you qualify for greater tax deductions? If you’re a manufacturing company, make sure you take advantage of the Section 199 Domestic Production Activities Deduction (DPAD.) DPAD’s generous tax deductions make it an appealing option for American manufacturers looking to maximize their income; however, it is important to note that the DPAD has some evolving rules and provisions that could affect compliance standards.
Among many other issues, there has been recent debate between the IRS and district courts over what manufacturing activities are eligible under Section 199. So the looming question is, at what point can a business claim that they are manufacturing? The IRS recently published proposed regulations (REG-136459-09) in an attempt to provide some guidance on this convoluted question.
What is DPAD?
In 2004, Congress enacted the DPAD as a way to provide tax relief for manufacturers in the United States. DPAD, which is largely aimed at catalyzing a more robust manufacturing environment in the U.S., stipulates that taxpayers are eligible for a deduction based on the income generated from qualifying production activities. Qualified domestic production activities include those that have been manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or in significant part within the United States.
The Recent Evolution:
Since its issuance, DPAD has been causing an array of confusion among taxpayers and enforcers alike. The loose interpretation of what falls under manufacturing, producing, growing or extracting (MPGE) has catalyzed a slew of businesses claiming to fall under the manufacturing umbrella.
With uncertainties as to what qualifies under MPGE, there have been two recent district court cases ruling against the IRS in favor of businesses claiming repackaging as a qualifying activity. Following these litigations, the IRS hit the drawing board with proposed regulations to strengthen and better define what exactly constitutes qualifying activities.
The Wins for Manufacturers:
Dean, Houdini Inc.
Houdini Inc. filed amended tax returns for 2005 and 2006 to claim the DPAD. Houdini, a company that created gift baskets and gift towers from various items from multiple suppliers, claimed that their use of an assembly line to change the form and function of the various items into one new product fell under the qualifications set forth by DPAD. The IRS fought the claim by saying that minor assembly or repackaging does not qualify as a MPGE activity.
The courts ruled in favor of Houdini, declaring that the assembly line changed the form and function of the various items in its production process. The result was the IRS releasing a regulation in 2015 that declared the following activities as non-MPGE: packaging, repackaging, labeling, or minor assembly.
Precision Dose Inc.
Shortly after the IRS released the proposed regulations for non-MPGE activities, another court case arose. Precision Dose, Inc., a company that creates single-dose medications from bulk, was denied their refund under DPAD by the IRS. Precision argued that their product, although derived from bulk items, was unique due to their complex production process. The IRS refuted the claim stating that Precision was merely repackaging and labeling an existing product and therefore failed to qualify as MPGE.
The courts ultimately ruled in favor of Precision, stating that their “complex production process,” which included research, product testing, and unique mixing, qualified them as creating a “distinct” final product.
What does this mean for me?
The arguments formed in both Dean and Precision Dose, Inc. serve to provide insight on the various ways in which a business can make the most of DPAD. While neither labeling nor repackaging alone directly qualify, persuasive arguments can be made for businesses that engage in additional processing activities.
In response to the court decisions, the IRS published proposed regulations (REG-136459-09) to better define and provide guidance on the DPAD provisions. These regulations, which will be effective when published as final, remain at odds with the recent court decisions as the IRS is seeking to administratively strengthen its position on DPAD. In light of the developing guidelines and DPAD’s evolving nature, it is beneficial to stay to up to date on provisions to ensure that your business’ activities are compliant.
If you have questions about your qualifications for a DPAD, feel free to contact one of Sensiba San Filippo’s DPAD tax experts at 925.271.8700 or at firstname.lastname@example.org.