What Is the Domestic Production Activities Deduction?
Passed by Congress in 2004, the domestic production activities deduction was intended to offer tax relief for businesses that produce most of their goods or work inside the United States rather than overseas. This deduction is no longer in use as it was replaced in 2017 by the qualified business income deduction related to the Tax Cuts and Jobs Act.
The Basics of the Domestic Production Activities Deduction
Also known as the Section 199 deduction, the domestic production activities deduction was in effect from 2005 through 2017 and applied to both small and large businesses that manufactured, grew, extracted, produced, developed or improved goods inside the United States. Using Form 8903, qualifying companies were able to claim the domestic production activities deduction based on a complex formula and set of rules.
Real-World Example: The Qualified Business Income Deduction
With the enactment of legislation known as the Tax Cuts and Jobs Act of 2017 on December 22, 2017, the Section 199 domestic production activities deduction was no longer available after 2017. In its place, Congress created the Section 199A deduction (note the “A”), also known as the qualified business income deduction, which no longer only applies to domestic manufacturing companies.
Instead, it permits owners of sole proprietorships, S corporations or partnerships to deduct up to 20% of qualified business income earned in a qualified trade or business, subject to limitations. The motivation of this deduction is to allow these business owners to keep pace with the significant corporate tax cut also provided by the Tax Cuts and Jobs Act of 2017.
While the purpose of the new Section 199A qualified business income deduction is clear, its statutory construction and legislative text are ambiguous. As a result, this deduction has created ample controversy since its enactment. Many tax advisers anticipate that until further guidance is issued, the uncertainty surrounding the provision could lead to countless disputes between taxpayers and the IRS.
This new version of the deduction is closely related to the deduction for Qualified Production Activities Income (QPAI), which is the portion of income derived from domestic manufacturing and production that qualifies for reduced taxation. More specifically, qualified production activities income is the difference between the manufacturer's domestic gross receipts and the aggregate cost of goods and services related to producing domestic goods. The tax-deductibility of QPAI is intended to reward manufacturers for producing goods domestically instead of overseas.