It seems hard to believe, but 2014 is the 10^th year in which an IRC section 199 domestic production activities deduction (“DPAD”) may be claimed.  Enacted as a replacement regime for the extraterritorial income exclusion, section 199 allows “manufacturers” to reduce their federal income tax rate by up to 3.15%.  The permanent tax benefit increases earnings per share and cash flow.

Most taxpayers that have “domestic production activities” are capturing the tax benefit by employing a process devised in 2005 either internally or with the assistance of an accounting firm. Depending on the sophistication of the taxpayer, and the resources it has committed to section 199 analysis, the process for capturing the benefit may have evolved considerably (or not) since its initial implementation.

Our experience suggests quite strongly that the processes implemented by taxpayers for year 1 (i.e., 2005) generally were good; but certainly were not great. We attribute this to a variety of factors.  As is true with many new tax provisions, taxpayers were forced to make decisions (with respect to process and with respect to technical issues) based on an incomplete knowledge base.  Most taxpayers also designed their section 199 process, not surprisingly, with an incomplete understanding of all the qualified activities, and related expenses, relevant to their company-specific DPAD determination.  We also are willing to hazard a guess that more than a few section 199 processes were designed in resource-constrained environments.

Ten years hence, and perhaps following some degree of staff turnover, it may make more than a little sense for many taxpayers to revisit their DPAD processes and results. We have found that many taxpayers underestimated the complexity involved in determining an optimal DPAD result.  To address the complexity that comes with, for example, multiple lines of business, cross-border operations, intercompany transactions, newly-acquired businesses, and the application of section 861 expense allocation and apportionment rules to multiple operative Code sections, corporate taxpayers, to a fairly significant extent, defaulted to calculations driven largely by process.

We have found during the course of numerous section 199 reviews that process-driven calculations can achieve optimal results only if (i) the process design was very sophisticated, (ii) there has been minimal turnover among the personnel administering the process, and (iii) the process is accompanied by a significant amount of annual, fact-specific analysis.  In our experience, that “trifecta” of circumstances almost never exists.

If your company (or your client) has, in its open tax years, an excess of taxable income over qualified production activities income, it may be time to have your section 199 results (and your process) scrubbed for additional permanent benefits.