March 2005                        return to newsletter contents page

New Business Income Tax Deduction Available for Certain U.S. Production Activities

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%.

More Information

Tax code provisions are usually complex and need to be applied to a company’s specific activities, with the advice of tax professionals. New section 199 is no exception. For more information on this income tax deduction provision and its potential applicability to your business refer to:

Treasury Department Fact Sheet dated January 19, 2005 (5 pages)

IRS Notice 2005-14 (102 pages)