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Combining Products to Form New Product May Qualify for Production Activity Tax Deduction


9/4/13

Synopsis:
 
Taxpayers who combine existing products to form a new product for sale may be engaged in a business endeavor that could entitle the taxpayer to claim the domestic production activity deduction (DPAD).
 
Issue:
 
A federal district court ruled that a taxpayer that designs, assembles, and sells gift baskets and gift towers is engaged in “qualified production activities” for purposes of the Internal Revenue Code Section 199 DPAD. In this case, the taxpayer’s enterprise was filling decorative containers with food and beverage items, arranging them decoratively, and selling the assembled gift items to customers. The taxpayer did not claim the DPAD on an originally filed return but later filed an amended return to claim the deduction and subsequent refund.
 
The IRS issued the refund to the taxpayer but later sued to recover the refund, claiming that combining products to make new products was not a qualified production activity. The IRS claimed that the taxpayer did not create new items, but merely packaged and re-packaged existing items. This activity is specifically excluded as a qualified production activity in the Treasury Regulations. However, the district court ruled that the production process changes the form of the food and beverage items into a new form when the taxpayer assembles the gift items. Because the individual items were transformed into a single gift, the process of doing this qualifies as a production activity for the DPAD. The court stated that the IRS and Treasury intended for the deduction to be available for a wide variety of activities and, therefore, the standards for qualified production activities should be interpreted as broadly as possible.


What Does CohnReznick Think?
This ruling resulted in a taxpayer-friendly outcome. In recognition of this ruling, CohnReznick thinks that  the “manufactured, produced, grown or extracted in the U.S.” requirement of the DPAD should be broadly defined.


Contact:
 
For more information, please contact the following CohnReznick tax professional:

To learn more about CohnReznick’s tax specialty services, please visit our webpage.


Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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