The Domestic Production Activities Deduction (DPAD) is an expired tax provision that manufacturers and qualifying businesses (qualified producers) could claim for years prior to 2018. The deduction is figured by taking 9% of the lesser of either qualified production activity income or taxable income. The total value of the deduction cannot exceed more than 50% of the W-2 wages business owners paid to employees in connection to qualified production activities income, and the business must report positive taxable income to claim the deduction.
While the deduction is subject to limitations, if you were a qualified producer between tax years 2005–2017, this tax provision led to significant savings. These are savings that you may be still able to claim on IRS Form 8903 for any original or amended tax return for the applicable tax years. While the DPAD has expired, you can learn about other opportunities to save in How To Calculate Small Business Taxes.
How To Calculate DPAD
You can figure your DPAD for the tax year by following this process:
- Step 1: Figure the amount of your business’s domestic production gross receipts (DPGR) from qualifying production activities.
- Step 2: Figure your business’s qualified production activities income (QPAI).
- Step 3: Figure the DPAD by multiplying the lesser of QPAI or the taxable income by 9%. DPAD cannot exceed 50% of the W-2 wages paid to generate the QPAI.
Figuring your DPAD requires you to perform a few calculations, so let’s look at each element to gain a better understanding of how this deduction works.
Domestic Production Gross Receipts
DPGR is income derived from the following qualifying production activities:
- U.S based manufacturing
- Making qualifying production property from scrap or salvage material or raw material by processing, manipulating, refining, or changing the form of an article or assembling articles
- The manufacture and production of tangible personal property and food storage, food processing, and wholesale food production
- Cultivating soil, raising livestock, fishing, and mining minerals
- Storage, handling, or processing in the United States related to the sale or disposition of agricultural products, provided the products are consumed in connection with, or incorporated into, manufacturing, producing, or growing qualifying production property
- Qualified film includes copyrights, trademarks, or other intangibles related to the film
- Oil-related QPAI attributable to the production, refining, processing, transportation, or distribution of oil or gas, or any primary product from oil or gas such as crude oil and products derived from the distillation of crude oil and products derived from shale oil derived from crude oil
DPGR must be determined on an item-by-item basis. Any component that meets the requirements may not be combined with a component that doesn’t meet the requirements of DPGR.
Qualified Production Activities Income
QPAI is the difference between DPGR and cost of goods and services related to producing the DPGR. This usually consists of the following:
- Cost of goods sold (COGS)
- Expenses and/or deductions
- Losses allocable to DPGR
Domestic Production Activities Deduction
Your domestic production activities deduction is 9% of the lesser:
- QPAI from the prior section
- Taxable income
However, your DPAD cannot exceed 50% of the W-2 wages you paid in qualifying production activities.
For oil-related businesses, you must reduce the DPAD by 3% of the least of the following amounts:
- Oil-related QPAI
- QPAI
- Adjusted gross income for an individual, estate, or trust (taxable income for all other taxpayers) figured without DPAD
Now that we’re more familiar with the elements of the DPAD, let’s look at examples to see how the deduction works for qualified producers.
Examples of the DPAD Calculation
Example 1
ABC Corporation is a small domestic manufacturing company that produces baseball equipment in Cooperstown, New York.
- 2016 DPGR: $380,000
- 2016 COGS: $100,000
- 2016 taxable income: $250,000
- QPAI: $280,000
- W-2-related QPAI: $100,000
Step 1: Determine the DPGR ($380,000).
Step 2: Determine QPAI ($280,000 = $380,000 DPGR – $100,000 COGS).
Step 3: Since ABC’s taxable income of $250,000 is less than its QPAI from Step 2, its DPAD for 2016 is $22,500 ($250,000 x 9%). And since its DPAD is less than 50% of the W-2-related QPAI of $50,000 ($100,000 x 50%), ABC can claim the full $22,500 deduction amount for 2016.
The QPAD will reduce ABC’s taxable income by $22,500 for 2016, bringing the total taxable income down to $227,500. This deduction will reduce the overall amount of taxes ABC will pay for 2016 tax year.
Example 2
In 2017, ABC Corp.’s taxable income was $400,000 and its qualified production activity income (QPAI) was $480,000. ABC didn’t pay any W-2 wages related to QPAI. Instead of hiring W-2 employees during the tax year, ABC paid $100,000 to 1099 workers. Since ABC didn’t pay any W-2 wages, ABC cannot claim a QPAD for the 2017 tax year.
Pros & Cons of DPAD
| PROS | CONS |
|---|---|
| Rewarded qualified producers for producing domestic goods | Requires the payment of W-2 wages, so you can’t use independent contractors |
| Allowed eligible business owners to reduce their taxable income | Cannot be used to create a net operating loss; excess DPAD can not be carried forward to future years |
| Allowed eligible business owners to claim a substantial tax savings | Is unavailable to sole proprietors and partnerships without employees |
Where DPAD Is Reported
| Entity Type | Schedule/Tax Form |
|---|---|
| Partnerships | Form 8903 & a footnote on Schedule K-1 |
| S Corporations (S-corps) | Form 8903 & a footnote on Schedule K-1 |
| C corporations (C-corps) | Form 8903 & Form 1120, Line 26 |
| Estates or Trusts | Form 8903 & Form 1041, Line 15a |
| Sole Proprietorships | Form 8903 & Form 1040, Schedule 1, Line 36 |
Frequently Asked Questions (FAQs)
Can I claim the domestic production activities deduction without any business income?
No, DPAD only applies to income from certain domestic production activities. So, if your business doesn’t have any positive income for the tax year, you cannot claim the deduction.
Can I claim DPAD without paying W- 2 wages?
No, if your business doesn’t pay any W-2 wages related to domestic activities, then your business cannot claim the deduction for the applicable tax years.
Will the DPAD ever be revitalized?
While DPAD expired on Dec. 31, 2017, Congress can revive the tax provision at any time. In the meantime, you can claim the Qualified Business Income Deduction (QBID), which allows eligible business owners to deduct up to 20% of their qualified business income on their tax return.
Bottom Line
The DPAD offered huge tax savings to both small and large businesses that engaged in domestic activities. Although DPAD expired on December 31, 2017, if for any reason you need to file or amend a 2005 to 2017 tax return, you can still claim the deduction and claim huge tax savings.
