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The Tax Prophet Newsletter   Issue # 31 February, 2005


In This Issue:
Eligible Taxpayers

New U.S. Production
Activities Deduction


To stimulate investment in the U.S. economy, Congress enacted Internal Revenue Code Sec. 199, providing tax relief to manufacturers investing in U.S.- based facilities, companies in the film and music businesses, software and building construction companies, and engineering and architectural firms.

Sec. 199 contains a new deduction of 3% for tax years 2005 and 2006 (rising to 6% in 2007 - 2009 and 9% thereafter) for taxpayers willing to run the gauntlet of complex rules, special definitions, limitations and accounting procedures issued by IRS.

Eligible Taxpayers

Modified gross receipts generated by the following business activities qualify for the deduction, provided the activities occur in whole or in significant part within the U.S.:

    (i) Tangible personal property and computer software manufactured, produced, grown or extracted;

    (ii) Film production - motion picture film, video tape or television programming with at least 50% of the paid for services performed in the U.S.;

    (iii) Construction activities - building or substantial renovations of residential and commercial buildings and infrastructure;

    (iv) Electricity, natural gas or potable water production; and

    (v) Engineering and architectural services.


The deduction has a ceiling equal to 50% of W-2 compensation, which means a business must have at least one W-2 employee on its payroll. If this threshold is met, then the deduction percentage (currently 3%)is multiplied by the lesser of: (i) modified gross income from the Sec. 199 activity or (ii) taxable income.

Eligible taxpayers include C corporations, sole proprietors, estates and trusts, partnerships, S corporations and LLCs.

Note: With respect to small businesses, these rules benefit primarily the construction and entertainment industries, software developers and agriculture (including the wine industry).

Financial, legal, medical, accounting and consulting services and professionals (except for engineering and architecture) generally cannot benefit from Sec. 199.


Assume taxpayer operates an architecture firm as a sole proprietor and has one employee earning $50,000 a year (the ceiling is 50% x $50,000 = $25,000). The company generates $600,000 in domestic architectural fees and taxpayer has a taxable income of $300,000.

Because taxable income is lower than the architectural fees, the Sec. 199 deduction is multiplied against taxable income. Here is a rough calculation of the Sec. 199 deduction:

Tax Years---------------- Sec. 199 deduction

2005 - 2006: ------------- $9,000 - 3% x $300,000

2007 - 2009: ------------ $18,000 - 6% x $300,000

2010 and beyond:------- $25,000 [the W-2 limitation is lower than 9% x $300,000 = $27,000]


Although the compliance costs to meet the requirements of Sec. 199 may outweigh the deduction in the initial year, the deduction grows from 3% to 6% in 2007-2009, and tops out at 9% in 2010 and thereafter.

Those companies qualifying for the deduction should carefully consider using this new and potentially significant tax break.

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All contents copyright © 2006 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.