1. Domestic Production Activities Deduction Chapter 7 pp. 213-243
2016 National Income
Tax Workbook™

2. Domestic Production p. 213 Activities Deduction
Terminology
Computing the Deduction
Limitations on the Deduction Amount
Reporting the Deduction on Form 8903
Pass-Through Entities
Agricultural & Horticultural Cooperatives
Specific Industries

3. DPAD p. 214 Domestic Production Activities Deduction
Tax years after 12/31/2004
Increasing rate – top at 9% since 2010
DPAD = smallest of
9% taxable income from QPAI
9% taxable income without DPAD
50% of W-2 wages attributable to DPGR
Allowed for both regular and AMT tax
See Acronyms listed – p. 214

4. QPAI pp. 214-215 Qualified Production Activities Income
QPAI = Domestic Production Gross Receipts (DPGR) less:
Items directly allocable to DPGR
Cost of goods sold
Deductions, expenses, losses
Ratable portion of items not directly allocable to any class of income

5. DPGR p. 215 Domestic Production Gross Receipts
DPGR = gross receipts from lease, rental, license, sale, exchange, other disposition of
Qualifying production property (QPP) manufactured, grown or extracted (MPGE) by TP, in whole or significant part, in the U.S.
Film production in certain circumstances
Electricity, natural gas, or potable water produced by the TP in the U.S.

6. DPGR p. 215 Domestic Production Gross Receipts
Includes receipts from:
If construction T or B: Construction or substantial renovation of real property in U.S.
If engineering or architectural T or B: services performed in U.S. relating to construction of real property
Self-constructed property used by taxpayer
Business interruption insurance proceeds & payments not to produce (if DPGR substitute)

7. DPGR pp. 215-216 Domestic Production Gross Receipts
Excludes receipts from lease, license, or rental for use by related person
Embedded Services
Generally, services do not qualify as DPGR
If services part of regular product price & not sold without product, some services in DPGR
Example 7.1 AC delivery fee in product price
Example 7.2 AC delivery fee separately stated

8. DPGR p. 216 Domestic Production Gross Receipts
De minimis exceptions
If embedded services < 5% of gross receipts, can include in DPGR
N/A if service amount separately stated
If non-DPGR receipts < 5% of total gross receipts, can include in DPG

9. QPP p. 216 Qualified Production Property
Tangible personal property (TPP)
Other than land, buildings, computer software, sound recordings, qualified films, electricity, natural gas, or potable water
Computer software
Sound recordings

10. MPGE p. 216 Manufactured, Produced, Grown, Extracted
Manufacturing, producing, growing, extracting, installing, developing, improving, creating QPP
Making QPP from scrap or new materials or by combining 2 or more articles
Cultivating soil, raising livestock, fishing, mining
Installing QPP is in another activity with the QPP
Storage, handling or other processing activities connected with certain agricultural products

11. pp. 216-217 MPGE Does not include
Transportation
Packaging, repackaging, labeling, or minor assembly of QPP
QPP installation if no other MPGE for the QPP
Example 7.3 – More than just repackaging
Example 7.4 – Service not MPGE
Example 7.5 – Assembly process = MPGE

12. p. 217 IRS Guidance on MPGE LB&I on retail activities not = MPGE:
Cutting blank keys to customer specs
Mixing base paint & paint coloring agent
Applying cake decoration if not baked where sold
Applying gas to ag products to affect ripening
Storing ag products to extend shelf life
Maintaining plants and seedlings

13. pp. 217-218 Installation Activities
Qualifies as MPGE if:
TP manufactured, produced, grew, or extracted the QPP and
During installation, TP had benefits & burdens of QPP ownership or is treated as meeting ownership rules of government contracts
Example Install of purchased parts
Example Install of Manufactured parts
Prop Regs – If QPP MPGE, install is MPGE

14. p. 218 MPGE by the Taxpayer
Business with ownership benefits & burdens during MPGE activity gets DPAD
Example 7.8
Fast Car contracts with Bob to build race car
Fast Car owns car at all times → gets DPAD
Example 7.9
Printer produces ads using ADVO specs but with materials it purchased – DPAD → printer

15. pp. 218-219 MPGE by the Taxpayer
Government contracts
MPGE treated as taxpayer’s activity even if title required to be transferred prior to completion
MPGE in whole or significant part w/in U.S.
50 states, D.C., U.S. territorial waters and seabeds and subsoils of any waters adjacent to U.S. territorial waters over which U.S. has exclusive exploration/exploitation rights
Puerto Rico if U.S. taxed & before 1/1/2017

16. p. 219 “In Whole or in Significant Part…”
Substantial in nature test – factors of:
Relative value added
Relative cost
Nature of the activity
Nature of the property
Example 7.10 – Figure 7.3
Assembles purchased parts into an auto
Substantial in nature = in significant part met

17. pp. 219-220 “In Whole or in Significant Part…”
Safe harbor test
TP’s direct labor & overhead costs for MPGE of QPP in U.S. ≥ 20% of QPP’s COGS or
No COGS, TP’s direct labor & overhead total ≥ 20% of QPP unadjusted depreciable basis
Example 7.11
Foreign parts $75, US labor $25 (25% of total)
Example Ex with labor of $3,000
Foreign parts $10,250, US labor 23% of total

18. p. 220 Computing the Deduction
DPAD = 9% x lesser of QPAI or taxable income
QPAI = DPGR less
COGS, expenses losses allocable to DPGR
COGS include:
Costs allocated to inventory under § 263A
Costs allocated to inventory under general inventory valuation rules – includes LIFO
Basis of noninventory if sales $ in DPGR

19. pp. 220-221 Computing QPAI - COGS
DPGR & non-DPGR? - must allocate
Reasonable method consistently applied
Small Business Simplified Overall Method
DPGR COGS = COGS x (DPGR/Total GR)
Average annual gross rec ≤ $5M for prior 3 yrs
Farmer not required to use accrual
Average annual gross rec ≤ 10M & cash o.k.
Example 7.13 – Figure 7.4

20. p. 221 Computing QPAI - COGS Example 7.13 – Figure 7.4
Builds custom pianos + tuning, repair services
Average GR prior 3 years of $5,000,000
Small business method for COGS
$2,290,000 x (3.500K/3.880K) = $2,065,722
QPAI = $ 1,434,278 (3,500,000 – 2,065,722)
Specific identification method
QPAI = $1,400,000 (3,500,000 – 2,100,000)

21. pp. 221-222 Computing QPAI – Other Costs
Other deductions/costs allocable to DPGR
I.R.C. § 861 method
More accurate but complex - costs may exceed benefit of using
Small business simplified method (SBSD) or
Allocated based on DPGR/Total GR
Simplified deduction method

22. p. 222 Computing QPAI – Other Costs
Simplified deduction method
If average annual GR ≤ $100M or total assets end of current year ≤ $10M
Extends small business method to other deductions allocation for those $5M to $100M
Must use chosen method for all deductions
May switch methods year by year
May use statistical sampling for allocations

23. pp. 222-223 Computing QPAI - Other Losses
§ 165 allocable to DPGR if property is QPP
Example Casualty – factory – ($50,000)
If TP built it: Allocable to DPGR
If TP purchased it: not allocable to DPGR
NOL (DPAD not in NOL carryover/back)
NOL not included in QPAI computation
NOL part of DPAD taxable income limitation
Example 7.15 and Effect of NOL

24. pp. 223-224 Rules for Expanded Affiliated Group
Expanded Affiliated Group (EAG) = 1 corp
Apply § 1504 using > 50% in lieu of ≥ 80%
Aggregate all taxable income/loss, QPAI and W-2 wages, remove GR from related entities
Membership in EAG determined daily
Member part year, has two DPAD amounts

25. pp Wage Limitation
DPAD may not > 50% W-2 wages properly allocable to qualifying production activity
Example 7.17 – Creating Wages for DPAD
$80,000 net – No wages
DPAD: $80,000 x 9% limited to -0-
Hires wife – salary $15,000
DPAD: $65,000 x 9% or $5,850 (< $7,500)
Balance with FICA & additional Medicare cost

26. p. 225 Wage Limitation
Wages from flow-through with a qualifying production activity flow to owner – may make Schedule C or F DPAD allowable
Example 7.18
Schedule F net of $150,000, no employees
10% interest in PS with qualifying activity
$15,000 income, $30,000 wages share
DPAD: $14,850 (165K x 9%) Limit: $15,000

27. p. 225 Taxable Income Limitation
Deduction limited to 9% of the lesser of:
Qualified Production Activities Income (QPAI) or
Entity taxable income without the DPAD
Individuals: limitation = AGI after applying §§ 86, 135, 137, 219, 221, 222, 469
AMT: Allowable for AMTI but not in AMTNOL
Individual: Same DPAD as for regular tax
Corp: 9% x lesser of QPAI (reg tax) or AMTI

28. pp. 226-227 Reporting DPAD on Form 8903
Joint return – combine items for Form 8903
Example 7.19
Schedule C: Figure 7.5
LLC: $3,000 QPAI and $1,000 wages share
1099-PATR, box 6: $850 share of DPAD
AGI $65,000
Figure 7.6, page 227, Form 8903

29. pp. 228-229 Pass-Through Entities
DPAD computed at partner or s corp SH level using allocated items from the entity
If basis, at-risk or passive limitations apply only proportionate share of each DPAD item used
In year items allowed, use in DPAD comp
Combine DPAD items from the entity with those of qualifying activities on owner’s return
DPAD does not reduce basis in PS or S corp

30. p. 229 QPAI Determined @ Entity Level
Some S corps or PSs may determine QPAI
Allocate QPAI and W-2 wages to K-1s
SH/PN cannot recalculate using another cost allocation method
Entities eligible to compute QPAI
§ 861 partnership
Eligible widely held pass-through entity
Eligible small pass-through entity

31. p. 229 QPAI Determined @ Entity Level
§ 861 partnership
≥ 100 PNs each day, ≥ 70% qualifying PNs
Not manager, < 5% interest, no material part.
Eligible widely held pass-through entity
S or PS, average GR ≤ $100M in 3 preceding and total assets ≤ $10M end of current
Has DPGR, COGS & deductions ≤ $10M
Owners every day: individuals, estates, QSST
No one owns > 10% (prof/cap int., shares)

32. p. 229 QPAI Determined @ Entity Level
Eligible small pass-through entity
PS or S corp qualified for small business simplified overall method
Has DPGR & total costs of ≤ $5,000,000
If PS, does not have ineligible PN or an EAG PS as a PN

33. p. 230 W-2 Wages & QPAI - Entity Level
Rev. Proc provides rules
Must account for separately and nonseparately stated items
Must include income items the inclusion of which is normally determined at PN/SH level
Must subtract expense items which the expense or capitalization is determined at PN/SH level
Must disregard any limitation on deductions applied at PN/SH level

34. p. 230 W-2 Wages & QPAI - Entity Level
Must account for expenditures for certain tax preferences w/optional write-off without regard to any PN/SH election
Must disregard any expenditure that the PN/SH could elect as deduction or credit
Must compute and account for any depletion under § 613A, without regard to any PN/SH level limitations

35. p. 230 W-2 Wages & QPAI - Entity Level
Must take into account increase/decrease in basis of PS assets under § 743(b)
Must exclude any entity items allocated by an eligible § 861 PS to a PN that is not a qualifying PN
QPAI will be < zero if entity’s DPGR is not > entity’s items deducted for QPAI

36. p. 230 Entity Level – Cost Allocations
Eligible § 861 PS must use § 861 method
Eligible widely-held pass-through entity must use simplified deduction method
Eligible small pass-through entity must use the small business method

37. pp. 230-231 Entity Level – Cost Allocations
Example Small Business Method
$2,000 gross receipts ($1,000 of DPGR)
$900 COGS (includes $400 W-2 wages)
$800 in other deductions
DPGR exp = $850 [( ) x 1,000/2,000)]
QPAI = $150 ($1,000 - $850), $75 to each PN
PN: DPAD = $75 x 9% or $6.75
(Wage limit = $100)

38. p. 231 Entity Level – Cost Allocations
Example Simplified Deduction Method
2 PNs: 50/50 but wages 80/20, other 20/80
$8,000 gross receipts ($6,000 of DPGR)
$4,000 COGS ($3,500 allocable to DPGR)
$3,000 other deductions ($2,000 marketing wages, $1,000 other expenses)
Eligibility for Simp Ded Meth at PN level
Cindy has $1,000 other GR, $200 wage exp.

39. p. 231 Example 7.21 Partner Calculation
Partnership Items (50% but 80% wages, 20% other)
$1,250 DPGR gross income ($3,000-$1,750)
$750 non-DPGR gross income ($1,000-$250)
$1,800 deductions (wages $1,600 + $200)
Cindy’s allocation of other items to DPGR
(3,000/5000) x ($1, ) = $1,200
QPAI = 50 ($1,250 - $1,200), DPAD = $4.50
Wage limit: $ % x [60% x ( )]

40. p. 231 Entity Safe Harbor – W-2 Wages
Small Business Method Safe Harbor
PS or S corp using small business method
% wages allocable to DPGR = DPGR/Total GR
Wage Expense Safe Harbor
PS or S corp using § 861 method or simplified deduction method
% wages allocable to DPGR = wages in QPAI/all wages for the year

41. pp. 232-233 Entity Allocating QPAI & Wages
Partnership
In same proportion as gross income or
Allocate in proportion to profits interests
Schedule K-1, Line 13 – Figure 7.7
S corp – in proportion to shareholder ownership
Schedule K-1, Line 12 – Figure 7.8
W-2 wages for DPAD allocated in same manner as allocated to PNs and SHs for the year

42. p. 233 Agricultural & Horticultural Coops
Can claim DPAD if MPGE agricultural or horticultural products
If Coop marketing treated as having MPGE in US from QPP if patrons MPGE the QPP
Nonexempt Sub T coops can exclude eligible distributions to patrons as patronage dividends or per-unit retain allocations
Includes per-unit retain paid in money (PURPIM)

43. p. 234 Agricultural & Horticultural Coops
Pass all/portion of DPAD through to patrons
On Form 1099-PATR – patron claims
Patron S corp or PS – separately stated item
No wage limitation on passed thru DPAD
Qualified products include fertilizer, diesel fuel, and other supplies used that are MPGE
Example 7.22
Markets patrons’ corn: coop receipts = DPGR

44. p. 234 Agricultural & Horticultural Coops
Example 7.23
Markets patrons’ corn
GR $1,500,000, Wages $130,000
Pays patrons $370,000 = per-unit retain allocations paid in money on 1099-PATR
Coop’s QPAI: $1,370,000 (1.5M-130K)
May pass thru DPAD if qualified payment made to patron

45. pp. 234-235 Agricultural & Horticultural Coops
Coop dividend paid deduction for patronage dividend is reduced by passed-thru DPAD
Coop is allowed to claim passed-thru DPAD to avoid “taxable income” that was passed on
If passed-thru DPAD later adjusted in audit, recapture at COOP level
Example $60,000 DPAD to patrons
$1M taxable income, $1M patronage div.
Coop: $1M - $940,000 - $60,000 = -0-

46. p. 235 Agricultural & Horticultural Coops
To extent payments to patrons treated as PURPIM, not deducted for QPAI
Must tell patrons amount of PURPIM
Patrons cannot use PURPIM as DPGR
Patron will need allocations for non-DPGR
PURPIM in Box 3, Form 1099-PATR

47. p. 235 Computer Software
Income from lease, rental, license, sale, exchange in US qualifies for DPAD
Computer software –
any program, routine, sequence of coding TP designs to make computer perform desired function
Includes video game and rights to use software
Does not include any TPP (diskette etc)

48. pp Computer Software
Example Software for video game, in U.S.
Reproduces and sells on a compact disc
Sale of both computer software and TPP
Sales of both = DPGR as MPGE in U.S.
Example Software for video game, not U.S.
Blue (not in US) licenses to Red (in U.S.) to manufacture and distribute
Red must allocate – only sale of disc = DPGR

49. p. 236 Computer Software – Use Online
Providing software for customer’s direct use while on internet is DPGR if
The taxpayer or an unrelated person regularly leases, sells, or licenses basically the same in tangible medium or by Internet download
Example Payroll Software
Provides access to customers on line for a fee
Competitor sells substantially same on disk
Gross receipts from online is DPGR

50. p. 236 Computer Software – Use Online
Example Inventory Control Software
Provides access to customers on line for a fee
No competitor sales of similar on disk
Gross receipts from online is not DPGR
All software games deemed substantially same
Free download with fee for use, not DPGR
R&E expenses for computer software & sound recordings included for substantial in nature & safe harbor tests (p. 219)

51. p. 237 Farming
Qualifying production: producing, growing, cultivating soil, raising livestock, fishing, mining, storage, handling, or other processing activities in the US related to sale, exchange or other disposition of agricultural products (not transport)
Must have ownership benefits & burdens while the producing or growing activity occurs
Example 7.29

52. p. 237 Farming Example 7.29 $500,000 sale of raise grain
$50,000 USDA subsidy (part for no crop)
$40,000 insurance for hail damage to crops
$10,000 custom combining services
1, 2 and 3 qualify as DPGR but not 4
As $10,000 < 5% of total → all treated as DPGR under de minimis rule (some exceptions apply)

53. p. 237 Construction of Real Property in US
DPGR: proceeds from sale, exchange or other disposition of real property constructed by TP
Real property: Buildings, inherently permanent structures, land improvements, oil & gas wells, infrastructure
Construction: to erect or substantially renovate the property (increase value, prolong life, adapt to new/different use)
Admin support services part of construction

54. pp. 237-238 Construction of Real Property in US
Grading, demolition, clearing, excavating, painting, landscaping, hauling trash, delivering materials = construction only if connected with qualifying construction activity
Construction T or B on a regular/ongoing basis
Derives GR from unrelated by selling or exchanging constructed real within 60 months of completion date
Can have DPAD without ownership of property

55. p. 238 Construction of Real Property in US
Example Substantial Renovation
Rebecca owns building. – no DPGR if sold
Steel hired as general contractor – has DPGR
Air Repair hired for AC install – has DPGR

56. pp. 238-240 Construction of Real Property in US
Example DPAD and AMT
Figure 7.9 – interest income < 5%, include
Figure 7.10 – Form (p. 239)
DPAD = $13,545 for regular tax
AMTI DPAD: lesser of QPAI or AMTI x 9%
150,500 (QPAI lesser) x 9% or $13,545
50% of wages - $175,000
Rental of real property not eligible for DPAD

57. p. 241 Engineering/ Architectural Services
Gross receipts = DPGR if services
Relate to real property
Are performed in the US and
Are for construction projects in US
Must be in the Tor B on a regular/ongoing basis
NAICS code of (eng), (arch)

58. pp. 240-241 Food or Beverage Sales
Retail establishment sales no DPGR
Food and beverage prepared, sold, and served
Take-out and delivery sales
Wholesale food sales = DPGR
Food & beverage held for sale by purchases
Food manufacturer/processing yields DPGR
Example Coffee shop + Production
GR from sale of beans roasted = DPGR

59. p. 241 Electricity, Natural Gas, & Potable H20
Lease, rental, license, sale, exchange = DPGR
GR from production = DPGR
GR from transmission and distributions NOT
Natural gas: all activities in extracting and processing it to pipeline quality = production
Potable water: acquisition, collection, storage of untreated, transportation to treatment facility, & treatment (but not storage after or delivery to customer)

60. pp. 241-242 Oil and Gas Industry
Extraction process and sale of product = DPGR
Activities related to drilling & generating IDC
NAICS – drilling O&G wells
NAICS – support – includes field services performed on contract/fee basis
Oil-related activity DPAD reduced by 3% of least of: oil-related QPAI, QPAI or taxable income
Oil-related QPAI = QPAI from production, refining, processing, transportation, distribution

61. p. 242 Oil and Gas Industry
After 12/31/15, independent refiners allocate only 25% of transportation costs to QPAI
Example 7.33
DPGR $400,000 Oil $300,000
Costs $100,000 Oil $75,000 ($50,000 trans)
Pre 2016: DPAD = $20,250
300,000 x 9% less 3% x (300,000-75,000)
Post 2015: DPAD = $22,500
337,500 x 9% less 3% x (300,000-25,000-12,500)

62. Questions?