Sounds Like Retailers Have Taken Some Creative Tax Positions

The IRS came out with a directive last week on the Section 199 deduction.  Here's a link.  Section 199 provides a special deduction for ""Qualified Domestic Production Activities" equal to 9% of "Qualified Production Activities Income."  If your business is the "manufacture, production, growth or extraction" of tangible personal property (which includes computer software and sound recordings), you are eligible for this deduction.  Income from producing films, electricity, natural gas or potable water and from construction activities also qualifies for the deduction.

The purpose of the deduction is quite simple: to provide a lower effective tax rate on income from producing goods as distinct from income from services.  I won't go into a explication of the sordid history of this provision, except to say that its rationale was to reverse the migration of manufacturing activities from the United States to foreign countries.

Interestingly, architects and engineers who provide services with respect to the construction of property also get the deduction.  I guess the lawyers who draw up the construction contracts didn't have the heft to get the same benefit.  Of course, workers don't get the benefit, even though they are actually the ones doing the "producing."

Anyway, the IRS apparently saw a need to issue a notice to its auditors regarding what constitutes "production" for purposes of this rule.  The notice is a list of activities that are not production.  Apparently, some people were being quite creative:

(1) cutting blank keys to a customer’s specification;

(2) mixing base paint and a paint coloring agent;

(3) applying garnishments to cake that is not baked where sold;

(4) applying gas to agricultural products to slow or expedite fruit ripening;

(5) storing agricultural products in a controlled environment to extend shelf life; and

(6) maintaining plants and seedlings. 

Yes, some hardware store (can you guess which?) was taking the position that duplicating a key and adding color to a base paint was "production."  Little did I know that Congress wanted to encourage these kinds of activities by giving them a reduced tax rate!

Sometimes I hate the fact that I'm a tax lawyer, because so many of us are coming up with this sort of shit.