In an effort to create and preserve US manufacturing jobs, Congress created a section in the American Jobs Creation Act of 2004, P.L. 108-357, enacted Sec. 199. Sec. 199 allows domestic manufactures to take deductions on production activities, which improves cash flow and makes investments in manufacturing facilities more attractive.
The original version of Sec. 199 was enacted in 2009 and accounts for 9% of the taxpayer’s qualified production activities income (QPAI) or the taxpayer’s taxable income. The deduction cannot exceed 50% of the Form W-2 wages for the tax year. Often the taxpayers enter into contractual agreements having other parties perform most or all the activities required to produce the qualifying production property (QPP) According to Sec. 199(d)(10), only one taxpayer can qualify for the deduction. The taxpayer that qualifies has to prove they have the burdens and benefits of the ownership of the QPP. This analysis is referred to benefits-and-burdens test.
Several times over the last few years, Congress has enacted a process to help determine the benefits and burdens, but the factors still only relied on the benefits-and-burden test. So in August, 2015, the Treasury proposed new regulations (REG-136459-09) addressing the issues of Sec. 199, including the benefits-and-burdens test. The new regulations would remove the benefits-and-burden test altogether. In its place, the Treasury would provide clearer guidelines on where the benefit and burden lies. The Treasury decided that in a contractual relationship, the party performing the Sec. 199 activity is eligible for the deduction. By doing this, the Treasury creates administrable consistent rules with a statue, they reduce the burden on the IRS and taxpayers who have to evaluate the benefits-and-burdens-of-ownership factors, and it prevents more than one taxpayer from taking the deduction.
By changing the way the law reads, it takes away the incentives to outsource to third parties because the taxpayer who is doing the work is the only one eligible for the deduction, instead of the property owner. This creates two problems. The first is without incentives, manufacturers will move production abroad where it cost significantly less money. The second is, if the manufacturer is unable to meet the requirements, then neither parties are eligible for the Sec. 199 deduction. Both of these problems defeat the purpose of what Congress was trying to do.