The domestic production activities deduction (DPAD) is a deduction available to businesses that produce goods in the U.S.  The deduction is not limited to manufacturers, however.  It includes the production of computer software, film, or utilities; the leasing, licensing or sale of property you produce, grow, or extract; as well as construction, engineering, and architectural services for real estate being built in the U.S.  The deduction is computed on IRS Form 8903.  For “pass-through” entities, such as partnerships and S-corporations, the DPAD information is passed through proportionally to the owners, and the owners compute their respective DPAD on their Form 1040’s as a page 1 adjustment to income.

The DPAD has two limitations, an income limitation and a wage limitation.  Therefore, an enterprise that has no employees (the sole proprietors and partners themselves cannot be W-2 employees) are not eligible for DPAD.

In determining the income limitation, it is necessary to compute your qualified production activities income. The first step is to calculate domestic production gross receipts (DPGR).  Subtract allocable cost of goods sold, and other allocable deductions from DPGR to arrive at “qualifed production activities income”.  The qualified production activities income amount is the maximum amount of your DPAD.  If the business engages in both DPGR and non-DPGR activities, the business will need to allocate cost of goods sold and other expenses between the two activities, in order to arrvie at your qualified production activites income amount.

Please keep in mind that state tax law regarding DPAD does not always follow federal tax law.  In New Jersey, the DPAD is limited to true manufacturers, so computer software engineers, construction contractors, engineers, and architects are not allowed to use DPAD for New Jersey income tax purposes. New York does not allow DPAD at all for either individuals or corporations.  Pennsylvania allows the DPAD for corporations, but not for individuals, S corporations, or partnerships.

If you have any questions about the domestic production activities deduction and how it may benefit your business, please contact Andrew Ross, CPA of Bedard, Kurowicki & Co., CPA’s at (908) 782-7900 or adr@bkc-cpa.com.