Tax Benefits from Manufacturing in the U.S.

The IRS has issued recent guidance related to the domestic production activities deduction (DPAD) that may be particularly favorable to moldmakers.


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Enacted in 2004, the domestic production activities deduction (DPAD) was intended to give a tax break to businesses that manufacture products in the United States rather than overseas. It is generally 9 percent of a company’s qualified production activities income (QPAI), which is basically income earned from domestic manufacture of a product. The DPAD is designed to be the economic equivalent of a 3-percent reduction in the tax rate on “qualifying activities.”

While this law is more than a decade old, the IRS has issued recent guidance discussed below, which may be particularly favorable to moldmakers.

Basics of the deduction. Qualifying income is equal to the difference between the business’ domestic production gross receipts (DPGR), or qualifying sales, and its allocable expenditures–the cost of producing those domestic goods. Qualifying sales are those sales from the manufacture, production, growth or extraction of qualifying production items in whole or in significant part in the U.S. Most U.S. moldmakers engage in qualifying activities, but, that said, they should not assume that all net income is qualifying income. 

Multiple parties involved in the same activity. IRS treasury regulations provide that only one business may claim the DPAD with respect to any qualifying activity that is performed in connection with the same qualifying product. This means the item must be manufactured 1) by the business and 2) in whole or in significant part within the U.S. This does not mean that multiple companies cannot have qualifying income for different stages in the manufacture of a product. Rather, meeting these two requirements allows different businesses to claim the DPAD for their stages within the overall production. 

Under current regulations, if one company performs a qualifying activity pursuant to a contract with another party, then only the taxpayer that has the benefits and burdens of ownership of the qualifying production property is treated as engaging in qualifying activity[1].  Determining which party has the benefits and burdens of ownership is based upon the facts and circumstances, and taxpayers should consider which party has: the risk of loss, title of the work in process (WIP), control over the production process, liability with respect to “make good” contractual provisions, and an opportunity to benefit financially from increased efficiencies in the production process. [1] Treasury Regulation §1.199-3(f)(1)

Directives for determining ownership benefits and burdens. Moldmakers should look to their relationships with both customers and vendors to determine whether another party has the benefits, as well as the burdens, of ownership during the manufacture of an item. In order to reduce ambiguity in contract manufacturing arrangements, the IRS has issued three directives to help taxpayers make this determination, with each one superceding the prior directive.

The first directive identifies three steps to determine which party has the benefits and burdens of ownership.

Step 1: Contract Terms

  • Does the taxpayer have title to the work-in-progress (WIP)?
  • Does the taxpayer have risk of loss over the WIP?
  • Is the taxpayer primarily responsible for insuring the WIP?

Step 2: Production Activities

  • Does the taxpayer develop the qualifying activity process?
  • Does the taxpayer exercise oversight and direction over the employees engaged in the qualifying activity?
  • Does the taxpayer conduct more than 50% of the quality control tests over the WIP while the qualifying activity was occurring?

If the taxpayer answers “yes” to two answers in each step, the taxpayer has the benefits and burdens of ownership during the manufacturing activity.  If not, taxpayers must proceed to step 3.

Step 3: Economic Risks

  • Is the taxpayer primarily liable under the “make good” provisions of the contract, for example, the warranty, quality of work, spoilage, overconsumption, or indemnification provisions?
  • Does the taxpayer provide more than 50%, based on cost, of the raw materials and components used to produce the property?
  • Does the taxpayer have the greater opportunity for profit increase or decrease from production efficiencies and fluctuations in the cost of labor and factory overhead?

If the taxpayer answers “yes” to two of the answers in Step 3, the taxpayer has the benefits and burdens of ownership during the manufacturing activity. 

In superseding the first directive, the second directive provides that both the taxpayer and the counterparty agree at the outset of the manufacturing activity which party has the benefits and burdens of ownership.

The third and final directive reiterates the safe harbor found in the second directive and requires the business to provide a statement that explains the basis for this determination. Further, this directive makes clear that if the parties have not agreed, it should not be presumed that the company does not have the benefits and burdens of ownership. Rather, the IRS must examine the facts and circumstances to make the determination for purposes of the DPAD.

Author’s Observation: While the first directive was superseded, the questions identified in each step are helpful to taxpayers in determining whether they have the benefits and burdens of ownership during the manufacturing process, based upon the relevant facts and circumstances.

Treasury scorches the earth with proposed regulations addressing which taxpayer receives the benefit in contract manufacturing arrangements. On August 27, 2015, the U.S. Treasury Department proposed regulations eliminating the benefits and burdens of ownership test.  In its place, the proposed regulations provide that if a qualifying activity is performed under a contract, then the party that performs the activity is the taxpayer that receives the benefit of the deduction.

Author’s Observation: This is a favorable development for mold builders, since the mold builder is typically performing substantially all (>80%) of the qualifying activity with respect to the mold build.  Therefore, the mold builder will reap the benefits of the deduction, assuming all of the other requirements are met.

A note about proposed regulations:  Proposed Regulations are just that – proposed.  They may not be relied upon until they are finalized in the Federal Register.  The proposed regulations request comments from the public with respect to the proposed changes.


The DPAD is an extremely beneficial provision of the Internal Revenue Code for companies that operate in the moldmaking industry in the U.S. Careful consideration of the requirements will help companies ensure they are calculating the proper amount of DPAD, as well as help establish procedures that substantiate such positions in the event of an IRS examination.

Mueller Prost