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On November 4,
2005, the Internal Revenue Service published
proposed regulations in the Federal Register
(70 Fed. Reg. 67220-67276) under Internal
Revenue Code section 199, on the recently
enacted deduction relating to domestic
production activities. For background
information please refer to the Background
section of this Advisory. The proposed
regulations expand on the initial guidance,
Notice 2005-14, that was issued in January 2005.
This NAW Advisory supplements our earlier
advisory issued in February 2005.
The proposed
regulations include many of the rules contained
in the initial guidance issued in January. In
addition, in response to over 80 public comment
letters received, the proposed regulations
provide many more comprehensive rules,
definitions, and examples to help taxpayers
implement this new provision.
The regulations
are proposed to be effective for taxable years
beginning after December 31, 2004, including for
pass-thru entities. Until proposed regulations
are finalized, taxpayers are generally permitted
to rely on the Notice 2005-14 as well as the
proposed regulations.
Please note that
electronic or written comments on the proposed
regulations must be filed with the IRS by
January 3, 2006 and a public hearing is
scheduled for January 11, 2006 in Washington,
D.C. Tax code provisions and IRS regulations are
usually complex and need to be applied to a
company’s specific activities, with the advice
of tax professionals. Code section 199 and the
proposed IRS regulations are no exception. For
more information on this income tax deduction
provision and related proposed regulations, and
the potential applicability to your business,
refer to:
Background
The American Jobs
Creation Act signed into law by President Bush
on October 22, 2004 included a new tax benefit
for certain “production activities” conducted in
the United States on or after January 1, 2005.
On January 19, 2005, the Treasury Department and
IRS issued a Notice under section 199 of the
Internal Revenue Code regarding the deduction
relating to income attributable to domestic
production activities. The Notice provides
interim guidance on which taxpayers may rely
until proposed regulations are issued.
The income tax
deduction under section 199 is not limited to
the traditional manufacturing company. It is
available for a wide variety of production
activities, including many activities which may
be carried on by a wholesaler-distributor or its
affiliated businesses.
Qualified
Production Activity Broadly Defined
The following
activities are among the qualified production
activities which are eligible for the income tax
deduction:
-
The
manufacture, production, growth or
extraction in whole or significant part in
the U.S. of tangible personal property or
software.
-
Construction
or substantial renovation of real property
in the U.S., including residential and
commercial buildings and infrastructure such
as roads, power lines, water systems and
communication facilities.
-
Engineering
and architectural services performed in the
U.S. and relating to the construction of
real property.
The term “produce”
includes (1) construct, build, install,
manufacture, develop, improve, create, raise or
grow (26 CFR 1.263A-2(a)((1)(i); and (2) also
includes reconstruct, making of property out of
scrap, salvage or junk material, as well as from
new or raw material, processing, manipulating,
refining or changing the form of an article, or
by combining or assembling two or more articles,
and includes soil cultivation, raising livestock
and mining materials (26 CFR 1.48.1(d)(2)).
Amount of
Income Tax Deduction
For 2005, the
deduction equals 3% of the lesser of taxable
income derived from a qualified production
activity; or taxable income, for the taxable
year. However, the deduction for a taxable year
is limited to 50% of the W-2 wages paid by the
taxpayer during the calendar year that ends in
such taxable year. In 2010, when the deduction
is fully phased-in, the 3% rate will have
increased to 9%. |
