Manufacturing Deduction Offers Significant Benefits to Construction ...
The deduction for income attributable to domestic production activities, often referred to as the ?manufacturing deduction,? originally enacted as part of the American Jobs Creation Act of 2004 is now old news. What you may not be aware of is that, beginning in 2010 tax years, the deduction is now equal to nine percent of a taxpayer?s ?qualified production activities income? (or ?QPAI?).
While coverage of the law has focused only on its application to manufacturers, the law actually refers to ?producers? not ?manufacturers.? In fact, construction contractors actually qualify as ?producers? under the law, which can mean significant tax savings. For a general contractor engaged in the construction of a commercial building on land owned by their customer, a profit of $500,000 on the project could mean a deduction of $45,000 before allocating indirect costs to the project or applying other limitations.
In general, QPAI is equal to domestic production gross receipts reduced by the sum of the costs of goods sold that are allocable to such receipts; other deductions, expenses or losses that are directly allocable to such receipts; and a proper share of other deductions, expenses and losses that are not directly allocable to such receipts or another class of income. The deduction is limited to 50 percent of the wages paid (as reported on Forms W-2) during the tax year, and cannot be greater than the taxpayer?s taxable income for the year. If you are thinking that this sounds like a cost accounting nightmare, you are correct ? but the tax savings could be well worth the trouble for many contractors.
How Do I Qualify?
To qualify, the taxpayer performing the construction must be engaged in a trade or business that is considered construction. Generally, construction will qualify if it includes activities directly related to the erection or substantial renovation of residential and commercial buildings and infrastructure. Infrastructure includes roads, power lines, water systems, railroad spurs, and communications facilities. Substantial renovation is defined as renovating a significant component or structural part of real property, such that the value of the property is materially increased, the useful life is substantially prolonged, or the property is adapted to a new use.
Revenue for construction services and labor, as well as receipts for materials and supplies consumed in the construction activity, will typically qualify as QPAI income. However, tangential services such as hauling trash and delivering materials do not qualify. Service contracts may qualify for the deduction, but only if the contractor manufactured, produced or extracted the material used in the service work. If the contractor installs parts or materials that were purchased, then the service work performed usually does not qualify for the domestic production deduction.
In some cases, subcontractors may also qualify for the deduction. For example, a roofing contractor installing the roof on a new building would qualify. But since the roofing contractor would not have produced the materials being installed, the gross profit from the resale of materials is not considered qualifying income. However, the profits attributable to the installation services would qualify as QPAI. For roofing contractors and other contractors that perform services both on new and existing buildings, the contractor must determine if the contract will qualify. The replacement of a roof on an existing building that is not done in connection with a substantial renovation will not qualify for the deduction.
What If I Have a Net Operating Loss?
The manufacturing deduction is limited to taxable income and there is no provision to carry forward any unused deduction. If you have a Net Operating Loss (NOL) carryforward to a taxable year that completely offsets your taxable income, no deduction is allowed due to the taxable income limitation. However, the NOL carryover to subsequent years is increased by the amount of the deduction that is disallowed. The same is true for NOL carrybacks.
The manufacturing deduction offers an important opportunity to reduce your tax liability if you are a construction contractor. However, the provisions of the governing law contain complexities which can be difficult to apply. You should consult with your advisors to insure that you obtain the maximum benefit available to you.
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- The Pros and Cons of Income Tax Basis Accounting for Construction Contractors
- Proposed Sec. 460 Regulations Apply Significantly to Contractors
Source: http://blogs.cbh.com/recon/?p=1187
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