LimitationsThe dollar amount of the Domestic Production Activities Deduction is limited. The deduction cannot exceed adjusted gross income (for sole proprietors, partnerships, S-corporations, or limited liability corporations) or taxable income (for C-corporations). Also, the deduction cannot exceed 50% of W-2 wages.
Domestic Production Activities Deduction cannot exceed:
Adjusted Gross Income, or
50% of W-2 Wages paid out
Simplified Method"The rules are simplified for a small business in a single line of business," according to Paul Schlather. Make sure your business qualifies under the qualified production activities rules, and then take 3% of net income. Compare the 3% figure to adjusted gross income and W-2 wages paid out. A business will not qualify for the Domestic Production Activities Deduction if it has zero net income or zero W-2 wages.
Where to Claim the DeductionBusinesses will need to fill out IRS Form 8903 (PDF). You can also download Instructions for Form 8903.
Tax LawInternal Revenue Code Section 199, and IRS Proposed Regulations 1.199. This deduction was part of the American Jobs Creation Act of 2004.
From the IRS
"For 2005 and 2006, the deduction equals 3% of the lesser of: (a) qualified production activities income; or (b) taxable income for the taxable year. However, the deduction for a taxable year is limited to 50 percent of the W-2 wages paid by the taxpayer during the calendar year that ends in such taxable year. The deduction is phased-in; for 2007 through 2009 the percentage increases to 6% and for 2010 and after the percentage will be 9%.(from IRS.gov, Brief Overview, no longer available online)
Qualified production activities include manufacturing, producing, growing, and extracting tangible personal property, computer software, and sound recordings, and the construction and substantial renovation of real property including infrastructure. The production of certain films is also a qualifying activity as are certain engineering or architectural services."