Dollars and Sense
Construction Industry Benefits from Manufacturing Deduction
Cheryl Fitzgerald
A tax incentive enacted to help offset the repeal of a tax break for U.S. exporters actually benefits many contractors and engineers as well. This tax incentive provides a deduction for many U.S. businesses that’s allowed for both regular tax and alternative minimum tax (AMT) purposes. The deduction has become known by many different names. It’s been called, among other things, the ‘U.S. production activities deduction,’ the ‘domestic production activities deduction’ (DPAD), and the ‘domestic manufacturing deduction’. For simplicity’s sake, we’re calling it the DPAD deduction.
The DPAD deduction equals a percentage of the net income from eligible activities — 9% after 2009. However, the amount of the deduction for any tax year may not exceed the taxpayer’s taxable income or, in the case of individuals, the taxpayer’s adjusted gross income.
As noted above, the DPAD deduction equals a percentage of the net income from eligible activities. Among the more common eligible activities are:
• The manufacture, production, or growth of tangible personal property, in whole or in significant part within the U.S.;
• The construction of real property in the U.S.; and
• The performance of engineering or architectural services in the U.S. in connection with real property construction projects in the U.S.
Purely sales activities aren’t eligible for the deduction, nor are purely service activities, except for construction, engineering, and architectural services.
Construction activities are eligible for the DPAD deduction, but only if the construction is of real property performed in the U.S. The real property may consist of residential or commercial buildings; permanent structures (like docks and wharves); permanent land improvements (like swimming pools and parking lots); oil and gas wells, platforms, and pipelines; and infrastructure (like roads, sewers, sidewalks, and power lines). Real property doesn’t include machinery unless it’s a “structural component” — for example, an elevator.
Examples of businesses conducting eligible construction activities are residential remodelers; commercial and institutional building construction contractors; foundation, structure, and building exterior contractors; structural steel and pre-cast concrete contractors; and electrical, plumbing, heating, and air-conditioning contractors.
Eligible construction activities don’t include tangential services such as hauling trash and debris, and delivering materials, even if the tangential services are essential for construction.
Construction includes ‘substantial renovation,’ but not decoration (or redecoration).
Substantial renovation does not include mere cosmetic changes, such as painting. However, painting is an activity constituting construction if it’s performed in connection with other activities (whether or not by the same taxpayer) that constitute the erection or substantial renovation of real property.
For purposes of the rules allowing the DPAD deduction for U.S. real property construction activities, real property construction includes substantial renovation of real property. Substantial renovation means the renovation of a major component or substantial structural part of real property that 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.
For example, a plumbing contractor’s installation of a plumbing system in a new building may qualify as a construction activity eligible for the DPAD deduction. However, replacing the fixtures in the bathroom of an existing house won’t qualify because the job isn’t connected with a construction activity — unless the work is performed as part of a substantial renovation.
The DPAD deduction is allowed to all taxpayers — individuals, C corporations, farming cooperatives, estates, trusts, and their beneficiaries. The deduction is passed through to the partners of partnerships and the owners of S corporations (not to partnerships or the S corporations themselves), and may be passed through by farming cooperatives to their patrons. And, despite the deduction’s history, it’s fully available to taxpayers who don’t export.
In addition to taxable income limitations, the amount of the DPAD deduction can’t exceed 50% of the business’s ‘W-2 wages’ paid to employees working in the qualified activity. This means that businesses operated as sole proprietorships or partnerships with no employees aren’t eligible for the deduction.
There’s a lot more to the DPAD deduction — for example, determining whether your particular business construction activities are eligible for the deduction, how to compute the net income from activities that are eligible, and how to determine the amount of the deduction when you’ve got income from both eligible and ineligible activities. The statutory rules are complicated, and the IRS has issued voluminous — and equally complicated — guidance on those rules. You should contact your accountant if you think that your constructing business activities may fall into a category that would allow for this deduction.
Cheryl Fitzgerald is a senior tax manager with the public accounting firm Meyers Brothers Kalicka, P.C., in Holyoke; (413) 536-8510.
