Recent Taxpayer-Friendly Section 199 Guidance On Benefits And Burdens Of Ownership


Section 199 allows a deduction equal to a percentage of a taxpayer’s income attributable to domestic production activities.1 For taxable years beginning in 2010 and thereafter, the deduction is generally equal to 9 percent of the lesser of either a taxpayer’s “qualified production activities income” (QPAI) or taxable income determined without regard to the deduction itself. QPAI for any taxable year is equal to the taxpayer’s “domestic production gross receipts” (DPGR), reduced by the sum of the cost of goods sold and below-the-line expenses allocable to DPGR.

On July 24, 2013 the IRS Large Business & International Division issued Directive 04-0713-006 (Directive) regarding Section 199 updating prior Directive 4-0112-001.2 The Directive provides much-needed guidance regarding which taxpayer may claim the benefits and burdens of ownership in a contract manufacturing arrangement and thus meet one of the requirements to claim the Section 199 deduction. As discussed in our May Tax Update, this has been a major source of controversy.3

Benefits and Burdens of Ownership

For a taxpayer to have DPGR and the ability to claim the Section 199 deduction, it must meet several requirements. One of those requirements is to have the DPGR derived from the sale of qualified production property manufactured “by the taxpayer.”4 Treas. Reg. Section 1.199-3(f)(1) further defines what is meant “by the taxpayer” in that only the taxpayer that has the “benefits and burdens” of ownership of the qualified production property during the period in which the production activities occur can claim the benefits of Section 199. This means that only one taxpayer may claim the domestic production activities deduction for the same function performed with respect to the same property. Consequently, with specified exceptions (e.g., for certain government contractors), if one party performs any qualifying Section 199 production activity under a contract with another party, then only the taxpayer that has the benefits and burdens of ownership of the property while the activity occurs is treated as having performed the qualifying Section 199 production activity with respect to that property.5 Parties cannot by contract designate which one is to be treated as having the benefits and burdens of ownership of the relevant property under federal income tax principles.6

The Directive instructs IRS agents, when analyzing whether a taxpayer has the benefits and burdens of ownership when engaged in a contract manufacturing arrangement, to request the taxpayer to provide three statements: 1) statement that explains the basis for the taxpayer’s determination that it had the benefits and burdens of ownership in the year or years under examination; 2) a “certification statement” signed by the taxpayer; and 3) a “certification statement” signed by the counterparty to the contract manufacturing arrangement. The certification statement signed by the taxpayer has language that the taxpayer has the benefits and burdens of ownership and the taxpayer is not required to reserve the amount of the deduction for financial statement reporting purposes under its accounting standard for its determination of the benefits of burdens of ownership. Taxpayers must still, however, have the benefits and burdens of ownership in order to assert the statements are accurate. The certification by the counterparty included language that it did not claim and will not claim the Section 199 deduction for any tax year. Although the Directive does not formally allow a taxpayer to designate who can claim the deduction, it does make it more clear between parties which may claim the deduction.

If these statements are timely provided to the IRS in response to its information document request, the Directive instructs the revenue agent not to challenge whether the taxpayer has the benefits and burdens of ownership over the qualified production property. If a taxpayer does not provide these statements, a taxpayer may still rely on the facts and circumstances to assert that it has the benefits and burdens of ownership.

Pepper Perspective

By allowing taxpayers to provide these statements, the IRS is taking a very practical approach to resolving a large amount of conflicts. Taxpayers entering into contract manufacturing arrangements would be advised to receive the counterparty certification (if accurate) contemporaneously with entering into a contract and maintaining the document in their tax files, as this will avoid having to potentially request the document in the future when the taxpayer comes under IRS examination.


1Unless otherwise stated, all references to “Section” are to the Internal Revenue Code of 1986, and all references to “Regulation” or “Treas. Reg.” are to the Treasury Regulations promulgated thereunder.

2LB&I-4-0713-006 (July 24, 2013) updated LB&I-4-0112-001 (Feb 1, 2012).


4Section 199(c)(4)(A)(i)(1).

5Treas. Reg. Section 1.199-3(d)(1) and Treas. Reg. Section 1.199-3(e)(1).

6See Preamble to TD9263, 5/24/2006.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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