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Attachment to IDD #3 on Domestic Production Deduction

Examples:

Assuming Company X is a calendar year taxpayer that uses the I.R.C. §861 method to allocate and apportion expenses to gross income attributable to I.R.C.§199 gross income:
 
1.  I.R.C. §861 Method Example (taxpayer declines to follow the simplified approach):

Employee A retired 12/31/2004 and Company X pays and deducts for tax purposes $10 of health insurance premiums with regard to Employee A in 2005.  Employee A worked in the legal department of Company X.  During Employee A’s career, he worked on Company X’s employment and personnel policies and procedures and employee complaints.  To determine what portion of the $10 health insurance premium payment that is factually related to I.R.C. §199 gross income, Company X must determine what portion, if any, is factually related to the generation of I.R.C. §199 gross income Company X earned in 2005 and future years.  To do this, Company X must analyze the activities of Employee A prior to retirement and determine whether those activities were factually related to the generation of I.R.C. §199 gross income in 2005 (and later years).  For each project that Employee A worked on, an analysis must be made to determine if those activities were factually related to the generation of I.R.C. §199 gross income.  Similarly, for work completed on policies and procedures, Company X must determine if those items are still in place and are factually related to the generation of I.R.C. §199 gross income.  Based on this analysis, a portion of the $10 may be factually related to I.R.C. §199 gross income and a portion to non-I.R.C. §199 gross income.  Company X must subtract from its I.R.C. §199 gross income in computing its QPAI for 2005 only the portion factually related to I.R.C. §199 gross income.

2. Simplified Method Example

Employee A works for Company X from January 1, 2003, to December 31, 2004.  He earned $1,000 that was deferred and paid in January of 2005.  Company X deducted this payment in 2005.  Under the simplified approach in this directive, only $100 (10% of $1,000) of Employee A’s deferred compensation is attributable to I.R.C. §199 gross income.  Accordingly, Company X must subtract $100 from its I.R.C. §199 income in computing its QPAI for 2005.

3. Cut-off Date Example

Employee B works for Company X from 2004 through 2006.  Employee B receives a bonus of $30 in 2006 that relates solely to activities performed in 2004 and 2005.  Company X deducted this bonus payment in 2006.  If Company X used the simplified approach provided in this directive, 10% of the bonus attributable to activities performed by Employee B in 2004 ($15) is attributable to I.R.C. §199 gross income and therefore, Company X must subtract from its I.R.C. §199 gross income only that portion in computing its QPAI in 2006 (subtract $1.50 from its I.R.C. §199 gross income).  The amount of the bonus that is attributable to 2005 ($15) will be allocated and apportioned to I.R.C. §199 gross income based on an analysis of the factual relationship of Employee B’s activities and whether those activities generated I.R.C. §199 gross income (see “If no simplified approach is taken” example above).

4. Cost of Goods Sold Example

Company X has $100 of employee compensation expenses that it includes in its cost of goods sold under I.R.C. §263A.  Company A may not allocate or apportion these expenses under I.R.C. §861 method in determining cost of goods sold allocate to DPGR under I.R.C. §199(c)(1)(B)(i) and Treas. Reg. §1.199-4(b).  Accordingly, Company X may not use the simplified approach in this directive to exclude any portion of its $100 of cost of goods sold from the determination of its I.R.C. §263A cost of goods sold that are allocable to DPGR under I.R.C. §199(c)(1)(B)(i) and Treas. Reg. §1.99-4(b).

Page Last Reviewed or Updated: 06-Nov-2014