CONSTRUCTION Accounting ARTICLE -The Inside Scoop On The Manufacturers’ Deduction
Target Audience: Construction Industry Professionals, Business Owners, Project Managers, Contractors, Construction Accountants
Many contractors have been taking advantage of a useful break with a somewhat misleading name: the manufacturers’ deduction. If you’re intrigued as to how your construction company can reap its benefits, read on for the inside scoop.
Beyond Manufacturers
The manufacturers’ deduction, also referred to as the domestic production activities deduction or the Section 199 deduction, is a product of the American Jobs Creation Act of 2004 (AJCA). That law provided a tax deduction not only for traditional manufacturers, but for other businesses as well.
In fact, the deduction’s definition of “manufacturing” encompasses a number of industries, including engineering, architecture, utilities, software, film production and, most important to you, of course, construction.
The deduction equals a certain percentage of the lesser of two figures, either:
- The “manufacturer’s” taxable income derived from “qualified production activity,” or
- Its taxable income for the year.
When introduced in 2004, the deduction for the 2005 tax year was 3%. It is 6% for the 2009 tax year and levels off at 9% for the 2010 tax year and beyond. The deduction, however, cannot exceed 50% of the W-2 wages paid to employees during the calendar year.
Qualifying Production Activities
While a number of services might be considered “qualified production activities,” you’ll need to zero in on activities that your construction company regularly performs. Under AJCA, construction-related qualified production activities include:
… construction or substantial renovation of real property in the United States, including residential and commercial buildings, and infrastructure such as roads, power lines, water systems, and communications facilities …
Taxable income derived from a qualified production activity (for example, construction activities performed in the United States) is determined by the gross receipts that result from the lease, rental, license, exchange or other transfer of qualifying production property, minus out-of-pocket costs such as materials expenses.
The Manufacturers' Deduction in Action
To give you a better idea of the benefits a contractor may reap from the manufacturers’ deduction, let’s look at an example.
Say, at the end of 2009, a contractor found himself with $2 million in net qualified production activities income (QPAI) and $1.5 million in taxable income. In this case, his deduction would be 6% of the lesser of the two — or $1.5 million, resulting in a $90,000 deduction.
Again, the deduction could be further limited because it cannot exceed 50% of the W-2 wages for the contractor’s employees. Fortunately, after checking the lesser of the total wages listed in Box 1 and Box 5 on his Forms W-2, the contractor confirmed that he was in the clear.
A Worthwhile Challenge
Perhaps the greatest challenge to claiming the manufacturers’ deduction is the diligent recordkeeping and administrative attention required to track qualifying activities and their related expenses — including labor and materials costs. For this reason, your CPA can be of great assistance in calculating your net QPAI and developing a plan for getting the most from this valuable tax incentive.
Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.
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