Special Deducation for Manufacturers May Also Benefit Construction Business

Melissa Lutgen, CPA, Tax Senior Manager   email
March 2011

 The American Jobs Creation Act of 2004 introduced a new deduction for domestic production activities known as the domestic activities production deduction. Activities eligible for the deduction were not limited to manufacturing activities performed in the United States, as the act also included construction activities performed in the United States.

The deduction was phased in over a five-year period. Beginning in 2005, the available deduction was 3 percent, and beginning in 2010, the deduction is fully phased in at 9 percent. The 9 percent deduction essentially results in a 3 percent reduction in the tax rate on eligible activities performed in the United States. For example, if your tax rate on business income from qualified activities would normally be 35 percent, the deduction would reduce this rate to approximately 32 percent. If you have not taken advantage of this tax opportunity in the past, the benefit you may experience now could be quite significant at the fully phased-in rate.

The deduction can be used by all types of taxpayers. While a C Corporation claims the deduction directly on its tax return, partnerships or S Corporations pass the deduction through to the owners to be claimed on their personal income tax returns.

Construction activities and services that are directly related to the erection or substantial renovation (not decoration or redecoration) of real property are eligible for the deduction. Real property, for purposes of the domestic activities production deduction, includes:

• Residential and commercial buildings;
• Inherently permanent structures and their components including items such as walls, partitions, doors, wiring plumbing, central air conditioning and heating systems, pipes and ducts, elevators and escalators, or other similar property;
• Inherently permanent land improvements (for example, swimming pools and parking lots);
• Oil and gas wells; and
• Infrastructure, including roads, power lines, water systems, railroad spurs, communications facilities, sewers, sidewalks, cable and wiring.

It is important to note that tangential services, such as hauling trash and debris and delivering materials, are not qualified construction activities in determining the domestic activities production deduction (even if these services are essential for construction).

Engineering services including consultation, investigation, evaluation, planning, design and supervision of construction projects are qualified activities for the deduction. Architectural services including consultation, planning, aesthetic and structural design and supervision of construction projects also qualify. All activities must be performed in the United States in connection with real property construction projects.

Determining whether or not you have activities eligible for the domestic production activities deduction is just the first step in claiming this deduction. Your tax professional can assist you with computing the income from activities that are eligible for the deduction and computing the deduction when you have both eligible and ineligible activities. Even if you have activities that qualify for the domestic production activities deduction, there may be other limitations that affect your ability to fully utilize the deduction. For example, the available deduction is limited to 9 percent of the lesser of the qualified production activities income or taxable income (adjusted gross income for individual taxpayers). Therefore, if you have a net operating loss for the year, you are not allowed to take the domestic production activities income deduction. In addition, the amount of the deduction allowed in a tax year is limited to 50 percent of the Form W-2 wages paid by the company during the year. It is also important to note that Wisconsin does not follow the federal provisions for the domestic production activities deduction, so any amount taken as a federal deduction must be added back in determining your Wisconsin income.

The rules surrounding the domestic activities production deduction are complex; however, pursuing the deduction can result in worthwhile tax savings for your company or owners.

For more information about the domestic activities production deduction or how to apply it to your company, contact Melissa Lutgen.