Construction Update
New Domestic Production Law Promotes Construction Jobs
Congress enacted the American Jobs Creation Act of 2004 in large part to promote the creation of jobs in manufacturing sectors.
But Section 199 of the Act, and the domestic production deduction (DPD) that it establishes, also offer benefits to construction and related firms.
The new law designates a range of U.S.-based manufacturing activities that qualify for the deduction — as well as new construction or major renovations in the U.S., and associated architectural and engineering services.
The new Act was Congress’s reaction to a ruling by the World Trade Organization (WTO) that certain tax incentives for export manufacturing constituted unfair trade subsidies. Those incentives will now be phased out; in their stead, the new incentives are intended to promote job growth in domestic manufacturing and construction segments. The deduction is not available for foreign construction activities on foreign soil.
Defining Construction Activities
The Act defines new construction as the creation of residential or commercial buildings on real property. Also included are most infrastructure projects — roads, power lines, water systems, railroad spurs, communications facilities, sewers, sidewalks, cable, wiring and permanent oil and gas platforms.
Major renovations, in the language of the Act, are those that involve work on a substantial structural part or major component of real property — work that increases value, extends life or adapts property for a new purpose.
Certain other activities may also qualify — grading, clearing, even painting — but only if they’re directly related to the erection or major renovation of actual buildings.
Tangible property — for example, appliances, furniture or fixtures — sold as part of a construction project doesn’t qualify unless more than 95 percent of the project’s total gross receipts is from construction attributable to real property.
What’s It Worth?
The amount of the deduction is scheduled to increase gradually over the next four years. (See boxed article on this page for details).
As an example, consider an S-corporation homebuilder whose entire gross income qualifies as construction receipts and who earns an annual net profit of $200,000. In 2006, the firm can deduct 3% of its net profits, or $6000.
Taxes without the deduction
$200,000 x 35% = $70,000 in taxes
Taxes with the deduction
$200,000 - $6,000 = $194,000
$194,000 x 35% = $67,900 in taxes
With the DPD, the firm will save $2,100 on taxes. The deduction will triple to nine percent starting in 2010 — generating tax savings of $6,300 for a firm like the one in our example.
More than one contractor can claim the deduction on the same receipts. A general contractor, for example, can take the deduction on its receipts for a project, and then the subcontractors who perform the work can claim the deduction on those same receipts.
The DPD is taken at the corporate level by C corporations and at the individual level by owners of “pass-through” entities like S corporations, limited liability companies and partnerships. The deduction will be taken on Form 8903, which exists in draft form.
Time to Measure
The deduction may begin at modest levels, but it’s worth attention now. By taking the time to categorize receipts and activities according to the Act’s criteria, companies will experience significant tax savings as well as potential accounting fees.
Accounting departments should put the necessary procedures into place, and review them in light of experience with the new deduction. As the deduction increases, a company’s ability to obtain a full reckoning of its qualifying activities and income will become more and more important.
Construction owners who begin installing appropriate measuring tools now will recap rewards this tax season, and even greater rewards in future years.
DPD: What and When - Winter 2006
Under the American Jobs Creation Act of 2004, a qualified taxpayer can deduct the lesser of:
- A percentage of its Qualified Production Activities Income (QPAI),
- The same percentage of its taxable income, or
- Fifty percent of the sum of its W-2 wages and certain elective deferrals made during the calendar year ending in the taxpayer’s taxable year.
The Act will be phased in over five years, as the percentage used calculating Options 1 and 2 changes as follows:
- 3 percent for tax years beginning in 2005 and 2006;
- 6 percent for tax years beginning in 2007, 2008 and 2009; and
- 9 percent thereafter.
For more information about our services to the construction industry, Contact:
Mark Lund, Parter-in-Charge of Construction Services at 713.297.6907.
The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.