Proposed Domestic Production Activities Deduction Regulations Change Rules for Contract Manufacturers
Sept. 3, 2015
On Aug. 27, the IRS issued temporary and proposed regulations that affect multiple parts of the 9 percent domestic production activities deduction (DPAD). Although the most significant of these changes relates to contract manufacturers, several other areas are affected as well.
- Under the current regulations, contract manufacturers are eligible for the DPAD if they meet a subjective benefits-and-burdens-of-ownership test related to their manufacturing activities. This criteria can result in disputes over who is permitted to claim the DPAD in a contract manufacturing arrangement and, in some cases, may disallow a DPAD to any party. The proposed regulations would eliminate the benefits-and-burdens test and permit the party performing the manufacturing activity to claim DPAD for its activities only if they are otherwise qualified manufacturing activities.
- Manufacturing activities that are insubstantial do not qualify for the DPAD. In the proposed regulations, the IRS changed one example to clarify that product testing activities alone are not qualified manufacturing activities. The IRS also added an example contrary to a district court decision that ruled that assembling a gift basket is not a qualified manufacturing activity.
- Construction activities generally qualify for the DPAD. The proposed regulations include several changes and anti-abuse rules related to qualified construction activities. Specifically, the proposed rules would provide that:
- General contractors will not qualify for the DPAD if they only approve or authorize payments and perform no other construction activities.
- Contractors required to use the percent-complete or completed-contract method should use allocable construction costs when computing the DPAD.
- Contractors performing substantial renovation activities for multiple buildings should determine whether gross receipts from each separate building represent receipts from a qualified manufacturing activity.
- The proposed regulations incorporate changes from the Energy Improvement and Extension Act of 2008, which limited the DPAD to 6 percent of taxable income from qualified oil-related production income.
- The proposed regulations incorporate changes from the Alternative Minimum Tax and Extenders Tax Relief Act of 2008, which amended the rules allowing a DPAD for qualified film production.
- The proposed regulations incorporate changes from the Tax Increase Prevention Act of 2014, which eliminated DPAD for manufacturing activities in Puerto Rico for tax years beginning after Dec. 31, 2014.
The proposed regulations are open for comment through Nov. 25, 2015, with a public hearing scheduled on Dec. 16, 2015. The proposed regulations generally are not effective until finalized.
In addition to the proposed regulations, the IRS also issued temporary regulations with a technical clarification. The DPAD is limited to 50 percent of domestic production wages paid and reported on a Form W-2, “Wage and Tax Statement.” The temporary regulations clarify that taxpayers filing a short-year tax return compute this limitation using wages actually paid during the short tax year regardless of whether Form W-2 is issued during that year. These regulations may be relied upon for all currently open tax years.
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