Originally enacted to help offset the repeal of a tax break for U.S. exporters, this provision of the tax code provides a deduction for many U.S. businesses that’s allowed for both regular tax and alternative minimum tax (AMT) purposes. And, despite the deduction’s history, it’s fully available to taxpayers who don’t export.
For 2010 and later years, the deduction equals 9% of the net income from eligible activities but cannot exceed 50% of the wages paid to employees whose work relates to the production of the income eligible for the deduction. This means that businesses operated as sole proprietorships or partnerships with no employees aren’t eligible for the deduction. To take advantage of the deduction, such businesses can incorporate and pay W-2 wages to their principals. (However, the decision to incorporate should not be based solely on claiming this credit - many other factors need to be considered.)
The following is an example of how this deduction works. Suppose your business manufactures a product which you wholesale to retailers. Your net income from sales of that product for the year is $550,000, and the wages you paid to your employees to manufacture that product totaled $100,000. Your deduction would be the lesser of 9% of the $550,000 in revenue or 50% of the $100,000 wages. Thus, your business’ domestic production activities deduction would be $49,500 (.09 x $550,000).
- The manufacture, production, growth, or extraction of qualifying production property (tangible personal property, computer software, and certain sound recordings) by the taxpayer in whole or in significant part within the United States;
- The production of any qualified film by the taxpayer if at least 50% of the total compensation relating to its production is compensation for services performed in the United States by actors, production personnel, directors, and producers;
- The production of electricity, natural gas, or potable water by the taxpayer in the United States;
- Real property construction in the United States; and
- The performance of engineering or architectural services in connection with U.S. real property construction projects.
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