Domestic Production Activities Deduction

What Is the Domestic Production Activities Deduction?

Passed by Congress in 2004, the domestic production activities deduction was intended to offer tax relief for businesses that produce most of their goods or work inside the U.S. rather than overseas. This deduction is no longer in use as it was replaced in 2017 by the qualified business income deduction that was introduced via the Tax Cuts and Jobs Act (TCJA) of 2017.

Understanding the Domestic Production Activities Deduction

Also known as the Section 199 deduction, the domestic production activities deduction was in effect from 2005 through 2017. This deduction applied to both small and large businesses that manufactured, grew, extracted, produced, developed, or improved goods inside the U.S. Using Form 8903, qualifying companies were able to claim the domestic production activities deduction based on a complex formula and set of rules.

Domestic Production Activities Deduction vs. the Qualified Business Income Deduction

When the legislation known as the Tax Cuts and Jobs Act of 2017 was enacted on December 22, 2017, the Section 199 domestic production activities deduction was no longer available. In its place, Congress created the Section 199A deduction (note the “A”), also known as the qualified business income deduction, which no longer only applies to domestic manufacturing companies.

The newly passed qualified business income deduction also permits owners of sole proprietorships, S corporations, or partnerships to deduct up to 20% of qualified business income earned in a qualified trade or business, subject to limitations. The motivation of this deduction is to allow this category of business owners to keep pace with the significant corporate tax deductions also provided by the Tax Cuts and Jobs Act of 2017.

While the purpose of the new Section 199A qualified business income deduction is clear, its statutory construction and legislative text are somewhat ambiguous. As a result, this deduction has created ample controversy since its enactment. When it was enacted, many tax advisers anticipated that until further guidance is issued, the uncertainty surrounding the provision could lead to countless disputes between taxpayers and the IRS.

This newer version of the deduction is closely related to the deduction for Qualified Production Activities Income (QPAI), which is the portion of income derived from domestic manufacturing and production that qualifies for reduced taxation. More specifically, qualified production activities income is the difference between the manufacturer's domestic gross receipts and the aggregate cost of goods and services related to producing domestic goods. The tax-deductibility of QPAI is intended to reward manufacturers for producing goods domestically instead of overseas.