On March 16, 2015, the Large Business and International (LB&I) division of the IRS issued a directive that includes examples of activities that generally are not qualified manufacturing activities for purposes of computing the domestic production activities deduction (DPAD). Businesses can claim up to a 9 percent (6 percent for oil-related income) DPAD against their taxable income for many domestic manufacturing, construction, engineering, and architectural activities. The IRS has been addressing more aggressively situations in which it believes taxpayers incorrectly have been claiming the DPAD.
The recent directive lists six specific activities that are considered nonqualified activities when performed at the retail level:
- Cutting blank keys to a customer’s specification
- Mixing base paint and a paint coloring agent
- Applying garnishments to cake that is not baked where sold
- Applying gas to agricultural products to slow or expedite fruit ripening
- Storing agricultural products in a controlled environment to extend shelf life
- Maintaining plants and seedlings
The activities highlighted in the directive are not surprising. An activity will not qualify for the DPAD unless it is “substantial in nature.” Although this is a subjective test, minor assembly and other similar activities that are not specifically labor- or capital-intensive are excluded from qualifying for the DPAD.
Businesses should note that this list is provided to IRS examiners as a guideline and is not authoritative to taxpayers. A taxpayer who undertakes some of the listed activities might still qualify for the DPAD depending on the specific facts and circumstances. For example, a full-service nursery that raises plants from seeds for sale at an attached retail facility generally could be considered as engaging in a qualified manufacturing activity, although some of the retail activities still might be disqualified for purposes of the DPAD.