Source: http://www.irs.gov/Businesses/Corporations/Industry-Director-Directive-on-Domestic-Production-Deduction-(DPD)-1
Timestamp: 2013-06-20 01:04:40
Document Index: 684126087

Matched Legal Cases: ['§861', '§199', '§861', '§904', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§1', '§1', '§199', '§1', '§199', '§ 861', '§861', '§199', '§199', '§199', '§861', '§199', '§199', '§199', '§861', '§199', '§904', '§199', '§1', '§174', '§1', '§199', '§1', '§1', '§1', '§861', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§1', '§199', '§199', '§199', '§199', '§199', '§199', '§199', '§861', '§199', '§199', '§199', '§199']

LMSB-Control Number: LMSB-04-0209-004
Large and Mid-Size Business Division Date: March 4, 2009
FROM: Charlie Brantley, /s/ Charlie Brantley
Industry Director, Heavy Manufacturing and Transportation and Issue Owner.
SUBJECT: Tier I - Industry Director Directive on Domestic Production Deduction (DPD) #3 – Field Directive related to compensation Expenses currently deducted but attributable to prior periods. This directive provides that LMSB examiners will not challenge returns that apply the method described below to allocate and apportion certain prior period compensation expenses under the I.R.C. §861 method in determining qualified production activities income under the I.R.C. §199 domestic production deduction. This directive was issued in recognition of the complexities inherent in applying the otherwise-required I.R.C. §861 analysis to such expenses for purposes of a newly-enacted statutory grouping; thus, this Directive does not apply for purposes of computing other statutory groupings, such as those required under I.R.C. §904. Similarly, this Directive applies only to currently deductible compensation expenses that relate to labor or personal services performed in taxable years beginning before January 1, 2005.
I.R.C. §199 was enacted as part of the American Jobs Creations Act of 2004, and is effective for taxable years beginning after December 31, 2004. I.R.C. §199 allows taxpayers to claim a deduction for a percentage of the lesser of qualified production activities income (“QPAI”) resulting from domestic production activities or taxable income (determined without regard to the I.R.C. §199 deduction). The applicable percentage is 3% for taxable years beginning in 2005 or 2006, increasing to 6% for taxable years beginning in 2007, 2008 or 2009, and further increasing to 9% for taxable years beginning after 2009. The I.R.C. §199 deduction is generally limited to 50 percent of the W-2 wages paid by the taxpayer for the taxable year. For taxable years beginning after May 17, 2006, the I.R.C. §199 deduction is limited to 50% of the taxpayer’s wages that are allocable to its domestic production gross receipts (“DPGR”). QPAI is the excess of the taxpayer’s DPGR for the taxable year over the sum of the taxpayer’s cost of goods sold (“CGS”) that is allocable to DPGR and the taxpayer’s other expenses, losses, and deductions (other than the I.R.C. §199 deduction) which are properly allocable to DPGR (“deductions”). A number of taxpayers have taken various positions with respect to allocating and apportioning prior period compensation expense deductions for purposes of computing QPAI. A prior period compensation expense is a compensation expense that is deductible by a taxpayer in the current taxable year that relates to labor or personal services performed for the taxpayer in a year prior to January 1, 2005 the effective date of I.R.C. §199 (“prior period compensation expense”). Certain taxpayers have asserted that prior period compensation expense deductions are per se excluded from the deductions that are properly allocable to gross income attributable to DPGR (DPGR less CGS allocable to DPGR)(I.R.C. §199 gross income) in the determination of QPAI under I.R.C. §199(c). This issue relates to taxpayers applying Treas. Reg. §§1.861-8 to 17 and Treas. Reg. §§1.861-8T to 14T, pursuant to I.R.C. §199(c) (1) (B) (ii) and Treas. Reg. §1.199-4(d), to allocate and apportion deductions to I.R.C. §199 gross income, which is referred to herein as the I.R.C. § 861 method. In general, the I.R.C. §861 method requires a taxpayer to allocate a deduction to a class of gross income and then, if necessary, apportion the deduction between the statutory and residual groupings of gross income based on the factual relationship between the expense and the gross income. Accordingly, some currently deductible expenses that relate to a prior period (even if that period predates the effective date of I.R.C. §199) may properly be allocated and apportioned to I.R.C. §199 gross income in a taxable year in which the taxpayer generates DPGR.
Taxpayers raising the prior period compensation expense deduction argument have asserted that it is reasonable to allocate and apportion all current-year prior period compensation expense deductions associated with labor or personal services performed in taxable years beginning before January 1, 2005, to the residual class of gross income (“non- gross income”) because the taxpayer could not have earned I.R.C. §199 gross income in the year or years when the labor or personal services were performed. Those taxpayers incorrectly apply the I.R.C. §861 method because they allocate and apportion current year prior period compensation expense deductions between I.R.C. §199 gross income and non- I.R.C. §199 gross income without considering the factual relationship between that deduction and the gross income generated by the labor or personal services. It is clear that, in certain circumstances, some of those services generate I.R.C. §199 gross income and the related deduction should therefore, under the I.R.C. §861 method, be allocated and apportioned to I.R.C. §199 gross income. Issue Tracking:
SSCM Issue: 199.04-02
ERCS Tracking Code 0540 On IMS, examiners need to accurately complete the ‘Issue Details’ screens. This includes input of the SAIN code, UIL code and ‘Adjustment Source’ information:
For the SAIN Code, select ‘SAIN Code 527 Domestic Production Deduction’ from the drop down menu.
Identify the proper UIL code. There are numerous UIL codes for Domestic Production issues. Examiners should select 199.04-02 for this issue.
If this issue is in the form of a claim, complete the ‘Adjustment Source’ screen to identify the type of claim, either ‘formal’ or ‘informal’ and any additional claim information.
The only deductions to which this directive applies are currently deductible payments for labor or personal services performed in taxable years beginning before January 1, 2005. This directive only applies to the allocation and apportionment of such prior period compensation deductions for purposes of computing QPAI, and does not apply for purposes of computing other statutory groupings of income, such as those required under I.R.C. §904. This directive is not applicable to any other deductions that the taxpayer must allocate and apportion under the Section 861 method under I.R.C. §199(c)(1)(B)(ii) and Treas. Reg. §1.199-4(d) neither is it applicable to any compensation expenses that are deductible as research and experimental expenditures under I.R.C. §174 and therefore are subject to the specific allocation and apportionment rules of Treas. Reg. §1.861-17. This directive does not apply to any items that the taxpayer must include in CGS and take into account under I.R.C. §199(c)(1)(B)(i) and Treas. Reg. §1.199-4(b). In addition, this directive is not applicable if the taxpayer uses either the simplified deduction method under Treas. Reg. §1.199-4(e) or the small business simplified overall method under Treas. Reg. §1.199-4(f) to determine QPAI.
In determining QPAI under the I.R.C. §861 method, as stated above, a taxpayer must determine whether the prior period compensation expense deduction is attributable to either I.R.C. §199 gross income or non- I.R.C. §199 gross income. Request from the taxpayer the amount and type of current year expense deductions that are excluded from the calculation of QPAI.
In order to avoid the burden associated with documenting the factual relationship between the prior period compensation expense deduction and gross income, the IRS has determined that it will not challenge the taxpayer’s computation of QPAI with respect to the amount of prior period compensation expense deduction taken into account in that calculation on returns that correctly apply the following approach with respect to that deduction:
A. Determine the total amount of the prior period compensation expense deduction in the current year attributable to labor or personal services performed in a taxable year beginning before January 1, 2005 the effective date of I.R.C. §199; and
B. Multiply the amount determined in section A by 10%; and C. The amount determined in section B is subtracted from I.R.C. §199 gross income in determining QPAI because it is deemed attributable to I.R.C. §199 gross income. The remaining 90% of the prior period compensation expense deduction is deemed attributable to non - I.R.C. §199 gross income, and therefore, should not be subtracted from I.R.C. §199 gross income in determining QPAI.
If this approach is taken, it must be taken consistently for all prior period compensation expense deductions taken by the taxpayer. This approach only applies for taxable years where the prior period compensation expense deduction is in issue.
If a taxpayer does not follow the above approach, the taxpayer will be required to furnish information supporting the factual relationship, for purposes of both allocation and apportionment, of the prior period compensation expense deduction to non- I.R.C. §199 gross income. LMSB examiners should request an explanation from the taxpayer of the relationship of its current year expenses that are excluded from the calculation of QPAI. This explanation must establish that the prior period compensation expense deduction is not factually related to I.R.C. §199 gross income. Under Treas. Reg. §1.861-8(f)(5), a taxpayer must furnish, if requested, information supporting the factual relationship, for purposes of both allocation and apportionment, of the deduction to the class of gross income and to the statutory grouping of gross income, in this case I.R.C. §199 gross income. Attached to this directive are pro-forma IDRs that may be used to gather the documents that would be required to support the factual relationship of the prior period compensation expense deduction to non- I.R.C. §199 gross income.
The allocation and apportionment of a prior period compensation expense deduction to I.R.C. §199 gross income and non-I.R.C. §199 gross income is determined by a factual analysis of the relationship between the deduction and I.R.C. §199 gross income and non -I.R.C. §199 gross income. It is clear that in certain circumstances some of the labor and personal services performed in taxable years beginning prior to January 1, 2005, to which the deduction relates, generate I.R.C. §199 gross income and that the related deduction should therefore, under the I.R.C. §861 method, be allocated and/or apportioned to I.R.C. §199 gross income. Thus, a taxpayer may not, without any factual analysis, allocate and/or apportion its entire prior period compensation expense deduction to non-I.R.C. §199 simply because the labor or personal services were performed in a taxable year beginning before January 1, 2005. In order to exclude the entire prior period compensation expense deduction from its QPAI calculation, a taxpayer must establish that the entire deduction is factually related to non-I.R.C. §199 gross income. Because this issue is extremely complex and time consuming, LMSB has provided an approach that, if applied correctly by a taxpayer, ensures that the IRS will not challenge the taxpayer’s computation of QPAI with respect to the amount of prior period compensation expense deduction taken into account in that calculation.
Pro Forma IDRs
If you have any questions, please contact Domestic Production Deduction I.R.C. §199 Technical Advisors Sandy Frost at (616) 365-4603 or Robert Schnuriger at (512) 464-3292.