One of the most generous business tax benefits included in the American Jobs Creation Act of 2004 is a new deduction for "domestic producers." This provision replaces the extra-territorial income exclusion many exporters used in the past but that the World Trade Organization declared illegal in 2000.
Under the new tax law, the deduction gradually phases in as the exclusion for exporters phases out. In addition, it applies not only to exporters, but also to many U.S. producers. As a result, many more entrepreneurs will benefit.
The break effectively allows a corporate tax deduction of 3 percent of net income in 2005 and 2006 for companies that meet the provision's requirements. The deduction increases to 6 percent in 2007, 2008 and 2009, then jumps to 9 percent in 2010 and beyond.
To be eligible, you must pass several tests. First, your company must have taxable income and you must have reported W-2 wages. The deduction is limited to the lesser of your taxable income, or 50 percent of the W-2 wages you paid during the tax year.
You also must be considered a domestic producer. Fortunately for many entrepreneurs, Congress has broadly defined the term producers to encompass not only traditional manufacturers of tangible personal property in the United States, but also the following:
- Businesses working on many U.S. construction projects
- Companies that perform civil engineering and architectural services for these construction projects
- Software producers in the United States
- Domestic farmers
- Companies that process agricultural products
- Most companies that deal with film and videotape production, renting and licensing
Even more beneficial is the fact that the new deduction is not limited to C corporations. It's possible for S corporations, partnerships and perhaps even sole proprietorships to qualify.
Keep in mind that the deduction is based on the net income from a company's production activities. Be sure to keep separate records if you engage in both production and nonproduction activities, says Sarah Williams, CPA and tax manager with Jackson, Rolfes, Spurgeon & Co. in Cincinnati.
For example, if a company manufactures water softeners and also services them, the income and expenses related to the production of the softeners vs. those related to the service activity must be recorded separately.
The Treasury Department is still formulating the exact details on how to calculate the new deduction. It plans to issue the rules within several months, so check this column for an update.
Great Falls, Virginia, writer Joan Szabo has reported on tax issues for 18 years.