By: Bryan Davidson, CPA, Senior Accountant
Are you capturing all the tax deductions available to your business? The Domestic Production Activities Deduction (DPAD) is an important one. The DPAD is available to sole proprietors, C-Corporations, S-Corporations and partnerships. In order to qualify for the deduction taxpayers must have domestic production gross receipts (DPGR) from qualified production activities. DPGR is broadly defined as gross receipts from the lease, rental, license, sale or exchange of any of the following:
- Tangible personal property
- Motion picture, file and sound video recording production
- Production of electricity, natural gas or water
- Construction or substantial renovation of real property (in the US)
- Civil engineering and architectural services for US construction projects
- Processing of food and agricultural products
A taxpayer’s total gross receipts must be allocated between DPGR and non-DPGR. If the non-DPGR is less than 5% of total gross receipts then all of the taxpayer’s gross receipts can be considered DPGR.
Once DPGR is determined the taxpayer must allocate cost of goods sold. This must be done by specifically identifying and tracing costs from its books and records. If this process will cause undue burden or expense any reasonable method can be used. Generally the same method used to allocate between DPGR and non-DPGR should be used. Also available is the small business simplified overall method to determine cost of goods sold allocable to DPGR. The taxpayer must have average annual gross receipts of $5 million or less. Average annual gross receipts are computed using the 3 years prior to the current tax year. This method allows taxpayers to allocate COGS and all other expenses based on the DPGR and non-DPGR percentage to total receipts. Another method for allocating other deductions is the simplified deduction method. This method is allowed for taxpayers with average annual receipts of $100 million or less or total assets of $10 million or less at the end of the tax year. With this method taxpayers can apportion other expenses and deductions (but not COGS) based on the percentage of DPGR and non-DPGR with total gross receipts.
The DPAD deduction is calculated by first determining qualified production activities income (QPAI). QPAI equals the DPGR less the allocable COGS and other expenses. The tentative DPAD deduction is 9% of QPAI. After this is computed it must be compared to the allocated wages included in the expenses that reduced DPGR. The DPAD is limited to 50% of these wages.
The DPAD deduction is claimed by completing Form 8903. This deduction is complicated to compute or in other cases completely overlooked. If you think you may qualify please contact one of our offices. We can provide further information on what activities are considered qualifying production activities and would be happy to assist you.