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IRS Directive Highlights Activities Ineligible for the Section 199 Domestic Production Activities Deduction


3/31/15

Synopsis
 
The IRS issued a new directive, LB&I-04-0315-001, to Large Business & International examiners on whether certain retail activities meet the definition of “manufactured, produced, grown, or extracted” (MPGE) for purposes of the section 199 domestic production activities deduction.  
 
Issue
 
Under section 199, a business may deduct an amount equal to 9% of qualified production activities income. In order to qualify for the deduction, the taxpayer must have qualifying income from items that it manufactured, produced, grew, or extracted (MPGE) in the United States. The directive’s objective is to address whether certain retail activities meet the MPGE requirement. The directive provides the following examples of activities performed at the retail level that fall outside the definition of MPGE as set forth in Treas. Reg. § 1.199-3(e):

  • Cutting blank keys to a customer’s specification
  • Mixing base paint and a paint coloring agent
  • Applying garnishments to a cake that is not baked where sold
  • Applying gas to agricultural products to slow or expedite fruit ripening
  • Storing agricultural products in a controlled environment to extend shelf life; and
  • Maintaining plants and seedlings
     

The directive indicates that other similar activities may fall outside of the MPGE definition. However, this will depend on the specific facts and circumstances surrounding the activities, the taxpayer’s industry, and processes through which the activities are performed. The IRS may expand the list of activities that do not meet the MPGE definition as appropriate.
 
What Does CohnReznick Think?
The directive is not an official pronouncement of law, and cannot be used, cited, or relied on as such. However, it does show situations in which the IRS will attempt to deny the section 199 deduction.

Whether activities rise to the level of production (MPGE) will be a question of fact. Certain activities that do not look like classic manufacturing may qualify for the deduction. For example, in a 2013 case, a federal court upheld a taxpayer’s section 199 deduction where a taxpayer assembled and sold gift baskets. (See United States v. Dean, 945 F. Supp. 2d 1110 (C.D. Cal. 2013)). In that case, the taxpayer had been taking items it did not manufacture and assembling them into “gift towers.” The court rejected the IRS’ argument that the taxpayer had been performing a mere service and found that the assembled gift tower was MPGE property, entitling the taxpayer to a deduction under section 199. In the case it was cited that “the IRS and Treasury believe that Congress intended the deduction under §199 to be available to a wide variety of production activities and therefore defined MPGE broadly.”

Notwithstanding the IRS’ view of MPGE, there may still be opportunities for retailers to claim the section 199 deduction under the right circumstances. Taxpayers should consider whether their activities might rise to the level of MPGE and whether the amount of activity they perform is significant enough to support the deduction.
 
Contact
 
For more information, please contact Richard Shevak, director, at richard.shevak@cohnreznick.com or 862-245-5029.
 
To learn more about CohnReznick’s Tax practice, please visit our webpage.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. 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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