Section 199 Deduction May Apply to Food and Beverage Production

Synopsis

Restaurants with off-site food preparation may qualify for the Section 199 deduction.

Issue

Overview

Section 199 allows for a domestic production activities deduction for qualifying domestic manufacturing and production activities. A business with "qualified production activities" may take a deduction equal to 9% of the lesser of: (1) the qualified production activities income ("QPAI") of the taxpayer for the tax year or (2) taxable income (determined without regard to Section 199) for the tax year. The tax deduction is further limited to 50% of the W-2 wages of the employer for the tax year.

QPAI is defined as income attributable to certain manufacturing, production, growing, or extracting (MPGE) activities from qualifying production property (QPP).

QPAI is the excess of domestic production gross receipts (DPGR) over the sum of:

(1) The cost of goods sold that are allocable to such receipts, and
(2) Other expenses, losses, or deductions (other than the deduction under Section 199) that are properly allocable to such receipts. 

Section 199 Application to Food and Beverage Production Activities

As it relates to food and beverage production activities, a Section 199 deduction is not available with respect to food prepared at the retail establishment (i.e., where retail customers come to purchase the food).  However, if a taxpayer prepares food off-site (i.e., not in a retail establishment) for sale either at some other location or for wholesale, the Section 199 deduction may be available.

The IRS defines a "retail establishment" as real property leased, occupied, or otherwise used by the taxpayer in its trade or business of selling food or beverages to the public at which retail sales are made.  For this purpose, "wholesale sales" are defined as sales of food and beverages that are resold by the purchaser. The Treasury Department and IRS  recognize that some establishments prepare food and beverages for both wholesale and retail sales. Even if a taxpayer's facility is a retail establishment, production of  food or beverages prepared at the facility and sold wholesale may still generate a Section 199 deduction.

The regulations under Section 199 contain several examples involving food producers:

Coffee retailers.

An example given in the Section 199 regulations makes it clear that roasting and packaging coffee beans at an off-site facility within the United States qualifies the taxpayer for the manufacturing deduction. Further, gross receipts derived from the selling of coffee beans roasted at the facility are DPGR.  However, the selling of brewed coffee or food prepared at the taxpayer's retail establishment is not qualifying production activities, and the gross receipts from these activities are non-DPGR.

Bakery Items.

Certain gross receipts derived from bakery production activities may qualify as DPGR.  As long as the bakery production activities occur in an off-site facility or the bakery products are sold at wholesale. The mixing of raw ingredients into ready to eat bakery items could potentially qualify as MPGE activity, assuming all other requirements of Section 199 are met – even if the final baking takes place at the retail facility.

What Does CohnReznick Think?

It is important to note that while restaurants are considered producers for purposes of Section 263A, those taxpayers must have sufficient MPGE activity at the item level to qualify for Section 199 deduction.  Where the food and beverage item is produced and/or processed is a significant factor in determining whether the activity is a qualifying production activity. Restaurants should closely examine their operations, especially as it relates to the production of food and beverage items for wholesale distribution, to determine if these activities qualify for the Section 199 deduction.

Contact

For more information, please contact Richard Shevak, a CohnReznick director, at richard.shevak@cohnreznick.com or 862-245-5029.

To learn more about CohnReznick's Hospitality Industry Practice, please visit our webpage.

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.