Written by Jason Herr, CPA
The U.S. Production Deduction or Domestic Production Activities Deduction (DPAD) is a valuable tax tool for businesses in the construction industry, yet it is still often not utilized properly. Are you missing out on this great tax benefit?
What is the Domestic Production Activities Deduction?
The DPAD is an additional deduction beyond your normal paid or accrued expenses that is calculated as a percentage of your qualified income.
What is the reason for the deduction?
The deduction aims to provide an additional incentive to help stimulate and support construction and production within the U.S.
How is the Domestic Production Activities Deduction Calculated?
The deduction is currently equal to the lessor of:
1. 9% of your qualified production activities income (QPAI). The calculation is derived from taking your qualified receipts minus the expenses associated with those receipts
OR
2, 50% of your eligible Form W-2 wages for that year.
For example, if your business had $1,000,000 net income for a year and ALL of your activities qualify for the deduction, your ending DPAD would equal $90,000 (QPAI of $1,000,000 x 9% = $90,000). This scenario assumes your Form W-2 wages were more than the $90,000 figure. There are various methods provided in the internal revenue code for how expenses are allocated to the qualified receipts.
What is the net tax break related to the Domestic Production Activities Deduction?
The dollar amount of your tax break depends on your tax bracket. In a scenario where you are in the highest tax bracket (currently 39.6%), the deduction would equate to 3.56% of your QPAI (9% x 39.6% = 3.564%). If we use this assumption in the dollar example mentioned earlier of $1,000,000 QPAI, the ending tax benefit then equates to $35,640 ($1,000,000 x 9% x 39.6% = $35,640).
Within the construction industry, what activities can qualify?
While not all construction activities qualify, more often than not, a business in the construction industry will qualify to some degree, if not to a great extent. For a taxpayer engaged in the active conduct of a construction trade or business, construction of real property performed in the U.S. by the taxpayer in the ordinary course of that trade or business is an activity that qualifies. Construction of real property is defined as a project to erect OR substantially renovate the property. To “substantially renovate” is the renovation of a major component or substantial structural part of the real property where that activity materially increases the value of the property, substantially prolongs the useful life of the property, OR adapts the property to a new or different use. Real property does NOT include ONLY BUILDINGS; it also includes structural components of buildings, inherently permanent structures, inherently permanent land improvements, oil and gas wells, and infrastructure. In addition, engineering, architectural, and other certain services can qualify when those services are performed in connection to the construction of real property.
When it comes to the Domestic Production Deduction, please allow the construction taxation experts at Trout CPA to assist you with determining which activities you are providing that qualify, calculating your deduction, and strategizing to maximize your tax benefit.
