The IRS offers a significant tax deduction for businesses that operate a considerable amount of their business domestically. Under a “safe harbor” rule, businesses can take Form 1040’s Domestic Production Activities Dedication (“DPAD”) (see Line 35) if at least 20 percent of total business expenses are the result of US-based direct labor and overhead costs.
While the IRS’ rules regarding this deduction are extremely complex, most small businesses in the manufacturing industry will qualify for the DPAD. Therefore, business-owning taxpayers that include business operations within their personal tax return may be able to claim this deduction. More specifically, the DPAD allows eligible taxpayers to deduct up to 9% of business income derived from the following activities1:
-Construction of real property in the United States
-Engineering or architectural services performed in the United States for construction of real property in the United States
-Any lease, rental, license, sale, exchange, or other disposition of either (i)tangible personal property, computer software, and sound recordings the taxpayer manufactured, produced, grew, or extracted in whole or in significant part in the United States, (ii) any qualified film the taxpayer produced, or (iii) electricity, natural gas, or potable water the taxpayer produced in the United States
The deduction does not apply, however, to income derived from:
-The sale of food and beverages prepared at a retail establishment
-Property the taxpayer leased, licensed, or rented for use by any related person
-The transmission or distribution of electricity, natural gas, or potable water
-The lease, rental, license, sale, exchange, or other disposition of land
Calculating the DPAD: The DPAD permits eligible businesses to deduct up to 9% of US-based business income. Taxpayers claiming the DPAD must complete Form 8903 to calculate the size of the deduction. Generally, the more complicated the business, the more complicated calculating the DPAD will be. As a result, any business expecting to claim the DPAD is strongly encouraged to implement cost accounting mechanisms to ensure properly calculations.
1The DPAD may be reduced if the taxpayer had oil-related qualified production activities income.
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