Recent Case Opens Door to “Manufacture” Additional Practice Tax Deductions
October 21, 2014
Most doctors think of themselves as providing professional services to their patients. In reality, they are also involved in “manufacturing” in their practice that can qualify them for added tax breaks. Unfortunately, most doctors and their CPAs are missing the mark.
Understanding Section 199
Congress added Section 199 to the tax law back in 2004 in order to stimulate U.S. manufacturing. Section 199 creates an added tax deduction, commonly referred to as the Domestic Manufacturing Deduction, equal to 9% of the net income generated from eligible activities. The term “manufacturing” is not defined in the tax law, but is commonly defined as “making into a tangible product suitable for use.”
This definition has been liberally construed. In fact, the Joint Committee on Taxation Report accompanying the law provided a “Starbucks rule,” noting that a taxpayer that buys coffee beans, roasts and then packages those beans at its facility, is engaged in manufacturing. Moreover, a recent California federal district court tax decision (U.S. vs. Dean) ruled that even arranging wrapped candy bars and wine bottles into gift baskets constitutes “manufacturing,” and thus qualifies for the Section 199 tax break.
Application in Dentistry
What activities would qualify in dentistry? The on-site production of crowns, inlays, onlays and other restorations, etc. using CEREC technology certainly qualifies. Likewise, doctors operating in-house labs to produce retainers, study models, appliances, etc. are also engaged in manufacturing that would qualify for the tax break.
Calculating the Tax Deduction
The calculations necessary to determine the allowable deduction for the doctor are quite complex, says Shanna Morales, CPA.* Doctors must first determine the amount of collections generated from those production activities, known as Domestic Production Gross Receipts. This amount is then reduced by related overhead costs to determine the related net income, known as the Qualified Production Activities Income (QPAI). The QPAI, or taxable income if lower, is then multiplied by 9% to arrive at the tentative deduction. However, in no case can the deduction exceed 50% of the W-2 wages for staff members involved in these lab and record-related activities.
Unlike virtually all other tax deductions, there’s no additional out-of-pocket expenditure required to generate it. While the complex calculations required to determine the deduction have caused many CPAs to simply throw up their hands and punt, Morales says that CPA firms that are familiar with dental practice operations can ferret out the information necessary to make the calculation. In many cases, this can provide the doctor with thousands of dollars in tax savings annually.
* Shanna Morales is a CPA with Elliot/ Davis, a CPA firm that specializes in providing tax preparation, accounting, and bookkeeping services to the dental profession. For more information, contact Marie Busbin at 704-808-5232.
*The above article was reprinted with permission from The McGill Advisory, a monthly newsletter with online resources devoted to tax, financial planning, investments, and practice management matters exclusively for the dental profession, published by John K. McGill & Company, Inc. Visitwww.mcgillhillgroup.com or call 888-249-7537 for further information.