LEGAL CORNER

Get ready to claim
your “QPAI deduction”


By Donald Frederick
Program Leader for Law,
Policy & Governance
USDA Rural Development
e-mail: donald.frederick@usda.gov


he American Jobs Creation Act of 2004 contains several provisions favorable to rural cooperatives and their member-users. One that will directly benefit many cooperatives and other businesses is the new Qualified Production Activities Income deduction.

The Qualified Production Activities Income deduction is first available for tax years beginning in 2005. This report is a summary of the terms used and general rules for claiming this new deduction. As this is somewhat complicated, readers are encouraged to discuss how this new deduction may benefit them with their professional tax adviser.

Three steps to success
Claiming the new deduction involves three computations. Congress has created some new tax jargon to describe these computations, so taxpayers will want to become familiar with these terms as they begin planning to maximize the benefit of the new deduction.

Step 1 — Compute “Domestic Production Gross Receipts,” which are the total gross receipts from any lease, rental, license, sale, exchange or other disposition of:
  1. Tangible personal property manufactured, produced, grown or extracted in whole or significant part in the United States,
  2. Electricity, natural gas or potable water produced in the United States, and
  3. Construction performed in the United States.
Step 2 — Compute “Qualified Production Activities Income,” which is your Domestic Production Gross Receipts determined in Step 1 minus:
  1. Cost of goods sold allocable to those receipts,
  2. Other deductions, expenses and losses directly allocable to those receipts, and
  3. A pro-ratable portion of other deductions, expenses and losses not directly allocable to such receipts or other income.
Step 3 — Compute your “Qualified Production Activities Income (QPAI) deduction,” which is your Qualified Production Activities Income multiplied by the applicable percentage for the tax year. The applicable percentage for each tax year, as set out in the law, are:
  1. 3 percent for tax years beginning in 2005 and 2006,
  2. 6 percent for tax years beginning in 2007 through 2009, and
  3. 9 percent for tax years beginning in 2010 and later.
While this may look simple, it may require some careful analysis to determine, for example, which receipts qualify as domestic production gross receipts or how to allocate costs between activities that generate domestic production gross receipts and those that produce other types of income.

Limitations on the QPAI deduction
Congress has included two upper limits on a taxpayer’s QPAI deduction:
  1. QPAI may not exceed taxable income for the year. If a taxpayer’s QPAI is more than its taxable income, the deduction is limited to taxable income times the applicable percentage for that year. If the taxpayer has no taxable income or a loss for tax purposes, the QPAI deduction is lost for that year.
  2. The QPAI deduction may not exceed 50 percent of W-2 wages paid by the taxpayer as an employer during the tax year. This is consistent with the general aim of the new law: to reward companies that create jobs in this country; it should not be a burden on cooperatives.
Special rules favor
manufacturing over service
The new law clearly favors businesses that produce things over those that perform services. This is illustrated by several special rules that apply to the computation of domestic production gross receipts (step 1 above) and distinguish between these two types of economic activity, including:
  1. Income from food processing (but not retail operations) is included.
  2. Income from processing, storing and handling (but not transporting) agricultural products used in manufacturing, producing or growing other goods is included,and
  3. Income from the production (but not the transmission or distribution) of electricity, natural gas and potable water is included.
Special rules for cooperatives
Congress wrote special rules into the new law to make sure cooperatives aren’t disadvantaged in their treatment compared to other types of businesses:
  1. When computing their Qualified Production Activities Income (step 2 above), cooperatives do not need to take into account their deduction for qualified patronage refunds and per-unit retains.
  2. Agricultural and horticultural cooperatives may pass through some or all of their QPAI deduction to their patrons. The cooperative must provide a written notice to its patrons explaining the pass-through within the applicable payment period.

This deduction is not simple, but it does offer a significant tax savings to cooperatives and other businesses that manufacture, produce, grow or extract hard products within the United States. Managers, directors and advisors are urged to study this new tax provision and incorporate it in their future business and tax planning efforts.





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