Manufacturers & Distributors ARTICLE -

Calm the Stormy Seas of Manufacturing Deductions with Safe Harbors

Target Audience: Manufacturing and Distribution Companies, M&D Industry, Manufacturing Distributors, Marketing Department Employees, Public Relations

You probably already know whether you qualify for the Section 199 qualified production manufacturing deduction, but do you know how best to apply the annual limit on that deduction?

For the 2007 tax year, you can deduct 6% of the lesser of your taxable income or your qualified domestic production activity income — whichever is less. In either case, your annual deduction can’t be more than 50% of the W-2 wages you pay in connection with the qualified activity.

That’s a change from previous years, in which the deduction was limited to total W-2 wages paid. This may not be a good change, however, because it may decrease your allowable deduction.

The good news is that there are two safe harbors you can use to determine how much of your W-2 wages are allocable to your domestic production costs. One is the wage expense method; the other is the small business simplified overall method.

With the wage expense method, you multiply W-2 wages by a ratio of the wage expense you use to calculate qualified production activity over the total wage expense you used to calculate taxable income.

As its name implies, the small business simplified overall method is somewhat, well, simpler. Determine the W-2 wages allocable to domestic production costs by multiplying your total W-2 wages by the ratio of your domestic production revenue to your total revenue (domestic production receipts / gross receipts x W-2 wages).

For example, let’s say you earned $1 million in total revenue last year and $175,000 of it was because of domestic production. You also paid $650,000 in wages. Divide $175,000 by $1 million and multiply it by $650,000, and you have $113,750 in domestic production wages. That makes your maximum deduction $10,500, which is 6% of your eligible domestic production income of $175,000. Had 6% of your domestic production income exceeded 50% of your wages allocated to domestic production, the deduction would be limited to the smaller amount.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

related links

M&D Newsletters & Articles 

Tax Services

Audit Assurance and Accounting

Industries

Tax and Business Updates