Domestic Production Activities Deduction

For businesses that manufacture or produce new assets, the IRS permits a Section 199 deduction on a form 8903, also known as the Domestic Production Activities Deduction. The deduction percentage equals the lesser of qualified production activities income (DPAI) multipled by 9% for 2010 or 50% of W-2 wage expenses. Individuals deduct DPAD on line 35 of the 1040 to arrive at AGI, while corporations deduct it on line 25 of the 1120, and 1065 and 1120S filers pass the deduction through to shareholders on the K-1.

QPAI is defined as domestic production gross receipts minus other direct costs allocable to such gross receipts. Sales tax is not included as a gross revenue.

W-2 wages are those wages paid to employees relating to domestic production gross receipts (DPGR). For instance lets take an example where an construction company has DPAI of $10,000,000, COGS of $5,000,000 and 75% of gross receipts are DGPR, with W-2 income relating to DPGR of $2,000,000. The DPAD deduction would be the lesser of $10m - $5m = $5m * .75 = 3.75m * 9% = $337,500 or $1,000,000 (50% of W-2 Wages). So if the entity was a C-Corporation they would deduct $337,500 on line 25 of Form 1120 as an expense.