The Basics of DPAD Deductions

Your CPA should explore all tax-saving opportunities for you, including the Domestic Production Activities Deduction (DPAD),under Internal Revenue Code Section 199. Those who are unaware of the DPAD — or intimidated by its perceived complexity — could be leaving money on the table.

Qualified activities

Companies engaged in these businesses may qualify for the DPAD:

  • U.S.-based manufacturing,
  • Selling, leasing, or licensing items manufactured in the United States,
  • Selling, leasing, or licensing motion pictures or recordings produced in the United States,
  • U.S.-based construction services, including building and renovation of residential and commercial properties,
  • Engineering and architectural services relating to a U.S.-based construction project, and
  • Software, including video game development in the United States.

Mining, oil extraction and farming also qualify as domestic production activities. Also, companies qualify even if their products are partially produced in the United States. Safe harbor rules permit companies to take the DPAD if at least 20% of total costs result from direct labor and overhead costs incurred domestically.


Lines of business specifically excluded from claiming DPAD include cosmetic construction services (such as painting), leasing or licensing activities to a related party, or the retail sale of food or beverages. The DPAD is generally equal to 9% of the smaller of a borrower’s qualified production activities income (QPAI) or its taxable income (or adjusted gross income for individuals, estates and trusts). The DPAD generally can’t exceed 50% of W-2 wages paid to employees.


If a borrower engages in only qualified domestic production activities, the QPAI usually equals its taxable income. Businesses that manufacture or produce partially outside the country will need to implement cost accounting mechanisms to make sure their tax deduction is accurately calculated.

To illustrate: Suppose ABC manufactures software in the United States. Revenues from domestic software manufacturing are $4 million with $2 million of domestic manufacturing costs. ABC also reports $500,000 of income from repairing software, which doesn’t qualify as a domestic production activity. Total W-2 wages were $600,000, including $400,000 to provide repair services.

Here, the QPAI equals $2 million ($4 million of software revenues – $2 million of manufacturing costs). ABC can deduct $180,000 under Section 199 (9% × $2 million of QPAI), assuming it has at least $180,000 of taxable income. The deduction also would be limited to W-2 wages attributable to software production ($600,000 – $400,000 = $200,000).

This is a simplified example. S corporations and other pass-through entities also qualify for the DPAD, which reduces their owners’ personal tax obligations.

If you think you might be eligible, please contact Holbrook & Manter today. We are very familiar with the DPAD and would be happy to assist you.