25 May 2006

Internal Revenue Code Section 199 Regulations

Section 199 is the part of the Internal Revenue Code that creates the "domestic production activity deduction", one of the most complex parts of the tax code ever enacted, with stunningly broad applicability. Now, the Internal Revenue Service has issued Section 199 regulations to govern it. The IRS notes in its press release that:

The section 199 deduction relating to domestic production activities was enacted in October 2004 as part of the American Jobs Creation Act, and was recently modified by the Tax Increase Prevention and Reconciliation Act of 2005. The deduction generally equals three percent of income from domestic production activities for 2005 and, by 2010, nine percent of such income. The activities eligible for the deduction include not only the manufacture of personal property such as clothing, goods, and food, but also the development of computer software, film and music production, the production of electricity, natural gas, or water, and construction, engineering, and architectural services.

The big problem is that every company that does some "domestic production" must essentially maintain two sets of books, one for the productive part of the business (e.g. Starbucks roasting beans for sale raw in package) and one for the rest of their business (e.g. Starbucks serving lattes to liberals, and selected cultured neo-conservatives). Drawing those lines turns out to be anything but obvious, and the scope of the exemption is such that it impacts industries far beyond the scope of traditional manufacturing, like construction and farming. Usually, complex tax breaks are reserved for large regulated industries, and not small businesses, both corporate and non-corporate, whose owners often prepare their own returns.

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