Signed into law by President Bush on October 22nd, the American Jobs Creation Act of 2004 is a complicated piece of legislation. The objective of this new tax act is to stem the trend toward overseas production that is of growing concern to everyone. The government hopes to achieve this goal by creating incentives that stimulate domestic "production activities." Because these activities are broadly defined, US construction firms are positioned to reap substantial tax savings.
The new tax deduction is, in essence, a reward for US firms that have earned income from manufacturing and other production activities in the United States . And a significant reward it is! It is anticipated that the savings to taxpayers, as a result of this incentive, will approach $77 billion over the next decade. Those taxpayers who reinvest this savings stand to benefit significantly. Says John M. Kiely, Managing Member of Kiely Equipment Company LLC, "This incentive will allow us to continue to invest in new equipment for our construction equipment rental business, which makes our customers very happy."
Of primary importance to Utility & Transportation Contractors Association members, and all construction contractors, is the main provision included in Internal Revenue Code Section 199. Although the tax deduction in Section 199 is informally referred to as the “manufacturers' tax deduction,” it is more accurately called the “domestic production deduction.” Candidates for the tax deduction include contractors and subcontractors performing a wide range of construction activities, as well as those firms that deliver certain engineering and architectural services.
To understand the tax savings to construction contractors, this article will examine four key issues.
- Who qualifies for the domestic production deduction?
- How is this deduction calculated?
- What questions remain unanswered?
- What do I need to do to prepare to take the deduction?
Qualifying for the Domestic Production Deduction
Under the American Jobs Creation Act, firms that earn income from certain domestic production activities qualify for the deduction. For many firms, only a portion of their income, that percentage derived from "qualified production activities," is eligible to receive the deduction.
What production activities are ‘qualified'? Section 199 contains a somewhat detailed list of qualified activities. Qualified construction activities include: activities related to the erection or substantial renovation of real property, both residential and commercial buildings; the construction of the infrastructure to support these buildings, including roads, sidewalks, and power lines; permanent land improvements, including grading and landscaping; painting (possibly); and communication facilities and utility construction, including sewer/water systems.
To qualify, activities must be related to substantial construction and not be merely cosmetic. Tangential services such as hauling debris may not qualify. Of course, the deduction applies only to activities performed in the United States .
Are subcontractors eligible or does this only apply to the general contractor? Because more than one taxpayer may be engaged in construction activities, all contractors performing qualified activities may apply the deduction, even if the taxpayer does not have the benefits and burdens of ownership of the property being constructed. For example, a general contractor and a sub-contractor may both be engaged in the construction of a new building. Each taxpayer will calculate the deduction based on the percentage of profits derived from his or her activities related to this project.