Allocation and apportionment of expenses for Sec. 199 purposes: for many taxpayers, calculation of the Sec. 199 deduction will require an enormous amount of work. This article focuses on one aspect of the deduction, the allocation and apportionment of expenses under the Sec. 861 regulations and the proposed Sec. 199 regulations.EXECUTIVE SUMMARY
* Sec. 861 REGULATIONS are integral to the Sec. 199 deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. when the Sec. 861 method of allocating deductions is used.
* Regs. Sec. 1.861-8 provides specific allocation The apportionment or designation of an item for a specific purpose or to a particular place.
In the law of trusts, the allocation of cash dividends earned by a stock that makes up the principal of a trust for a beneficiary usually means that the dividends will be treated as rules for some expenses, such as interest and R&E, and a two-step process for other expenses not specifically provide for.
* Taxpayers that will use the Sec. 861 rules in a Sec. 199 context may want to reconsider re·con·sid·er
v. re·con·sid·ered, re·con·sid·er·ing, re·con·sid·ers
1. To consider again, especially with intent to alter or modify a previous decision.
2. prior elections under Sec. 861.
Many calendar-year taxpayers have yet to file their first U.S. income tax return that includes the Sec. 199 deduction introduced by the American Jobs Creation Act of 2004 (AJCA AJCA American Jobs Creation Act of 2004 (US)
AJCA American Jersey Cattle Association
AJCA Association of Juvenile Compact Administrators
AJCA All Japan Cooks Association
AJCA Alabama Junior Cattlemen’s Association ). Even so, taxpayers have certainly needed to calculate the likely deduction, for both estimated tax Federal and state tax laws require a quarterly payment of estimated taxes due from corporations, trusts, estates, non-wage employees, and wage employees with income not subject to withholding. and financial reporting purposes. What is clear to anyone who may benefit from the deduction is that the calculation requires an enormous amount of work. Almost every aspect of the section requires careful analysis: What constitutes "manufacturing"? What is "substantially within the U.S."? What is "by the taxpayer?" This article will focus on only one of the multiple complex pieces of the Sec. 199 puzzle “Puzzle solving” redirects here. For the concept in Thomas Kuhn's philosophy of science, see normal science.
A puzzle is a problem or enigma that challenges ingenuity. : the allocation and apportionment The process by which legislative seats are distributed among units entitled to representation; determination of the number of representatives that a state, county, or other subdivision may send to a legislative body. The U.S. of expenses. For taxpayers who have claimed a foreign tax credit (FTC FTC
See Federal Trade Commission (FTC). ), these rules are not new (but still mysterious). For those who may benefit from Sec. 199, but have never claimed an FTC or otherwise needed to use Sec. 861, the roles must seem baffling baf·fle
tr.v. baf·fled, baf·fling, baf·fles
1. To frustrate or check (a person) as by confusing or perplexing; stymie.
2. To impede the force or movement of.
Sec 199 provides a deduction equal to 3% (increasing to 6% for 2007, 2008 and 2009 and then to 9% for 2010 and there after) of the lesser of qualified production activities income (QPAI) or taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . The domestic manufacturing deduction (DMD (1) (Digital Micromirror Device) See DLP.
(2) (Digital Multi-layer Disk) See high-def DVD formats. ) is limited to 50% of W-2 wages.
To determine QPAI, a taxpayer must reduce its domestic production gross receipts the total of the receipts, before they are diminished by any deduction, as for expenses; - distinguished from net profits.
See under Gross,
See also: Gross Receipt (DPGR DPGR Digital Photography Greece
DPGR Domestic Production Gross Receipts ) (1) by:
1. Cost of goods sold Cost of goods sold
The total cost of buying raw materials, and paying for all the factors that go into producing finished goods.
cost of goods sold (COGS These are all the Cogs found in Disney's Toontown Online. Names that are moved forward are leaders of the HQ of that specific Cog type. Bossbots
Capable of being allocated.
Adj. 1. allocable - capable of being distributed
distributive - serving to distribute or allot or disperse to DPGR.
2. Deductions directly allocable to DPGR.
3.A ratable That which can be appraised, assessed, or adjusted through the application of a formula or percentage.
Ratable property is that which is taxable or capable of being appraised or assessed.
ratable adj. portion of deductions not directly allocable to DPGR or to another class of income.
To determine the deductions directly allocable to DPGR and the portion of deductions not directly allocable to DPGR or to another class of income, Prop. Regs. Sec. 1.199-4(c) provides that taxpayers generally must follow the rules in the Sec. 861 regulations. In addition to the methods and principles of allocation and apportionment under Sec. 861, the proposed Sec. 199 regulations provide two alternative methods for the apportionment of deductions other than COGS: (2)
1. The simplified deduction method, which may be used by taxpayers with $25 million or less average annual gross receipts or total assets at the end of the year of $10 million or less; and 2. The small business simplified overall method, which may be used by taxpayers eligible to use the cash method, those that have $5 million or less average annual gross receipts and $5 million or less total costs for the current year, or certain other taxpayers engaged in the farming business.
If a taxpayer qualifies for one or both of the alternative methods, it may choose the method of allocation and apportionment on an annual basis, (3) provided the taxpayer continues to qualify for the method chosen.
Why Section 861?
The Sec. 861 regulations provided the drafters of the Sec. 199 guidance a ready set of rules for the allocation and apportionment of deductions. Although the principal application of the Sec. 861 regulations has been the determination of foreign-source taxable income for purposes of the FTC limitation, they also apply to many other Code sections ("operative OPERATIVE. A workman; one employed to perform labor for another.
2. This word is used in the bankrupt law of 19th August, 1841, s. 5, which directs that any person who shall have performed any labor as an operative in the service of any bankrupt shall be sections"). (4) Thus, these rules were easily adopted for Sec. 199 purposes.
Regs. Sec. 1.861-8(f)(1) already contains an extensive list of the operative sections which require the determination of taxable income from specific sources or activities. Under the proposed Sec. 199 regulations, Sec. 199 would be treated as an operative section if the taxpayer uses the Sec. 861 method for purposes of allocating deductions to DPGR. (5)
Regs. Sec. 1.861-8 prescribes the general rules for allocating and apportioning ap·por·tion
tr.v. ap·por·tioned, ap·por·tion·ing, ap·por·tions
To divide and assign according to a plan; allot: "The tendency persists to apportion blame as suits the circumstances" deductions primarily for the purpose of computing computing - computer taxable income from sources within and without the U.S., and was initially adopted in 1977. Subsequently, Treasury has enacted various changes to the Sec. 861 regulations to provide additional guidance on expense allocation and apportionment. Such regulations are now integral to the determination of a taxpayer's DMD when the Sec. 861 method of allocating costs is used. Some of these post- post- word element [L.], after; behind.
1. After; later: postpartum.
2. Behind; posterior to: postaxial. 1977 changes include the adoption of specific mandatory allocation and apportionment rules for the following deductions:
* Research and experimental (R&E) expenses.
* Stewardship stewardship
the occupation of being a steward or custodian. Referring to animals it implies the caring sort of relationship based on an acceptance of the need to include the rights of animals in overall plans to maintain financial viability. expenses.
* Supportive expenses.
* State and local income taxes.
* Net operating losses Net operating losses
Losses that a firm can take advantage of to reduce taxes. (NOLs).
* Losses on the disposition of property.
* Legal and accounting fees.
* Charitable contributions charitable contribution n. in taxation, a contribution to an organization which is officially created for charitable, religious, educational, scientific, artistic, literary, or other good works. .
* Dividends received deduction (DRD DRD Dopa-Responsive Dystonia
DRD Dividends Received Deduction
DRD Drag Rescue Device (firefighter bunker)
DRD Deputy Regional Director
DRD Data Requirements Document
DRD Direct Reading Dosimeter
DRD Department of Redundancy Department ).
The Sec. 861 regulations provide detailed rules for the allocation and apportionment of each of these deductions, and in some cases the computations can be very complex. For deductions other than those listed above, the Sec. 861 regulations establish an overall two-step approach--(1) allocation to a class of gross income and (2) apportionment within the class of gross income--to determine the deduction amount that must be attributed to certain statutorily defined types of gross income for purposes of computing taxable income. Regs. Sec. 1.861-8 provides a general set of criteria for determining the class of gross income to which a deduction is allocated, and the apportionment method used to divide the deduction between the "statutory" and residual groupings of gross income within the class of gross income. (6) Such apportionment includes apportionment between U.S.- and foreign-source income Foreign-source income
Income earned from international operations. for FTC limitation purposes, and between gross income attributable to DPGR, and gross income attributable to non-DPGR for purposes of the Sec. 199 DMD, among others.
Deductions of a domestic corporation are generally not allocated and apportioned ap·por·tion
tr.v. ap·por·tioned, ap·por·tion·ing, ap·por·tions
To divide and assign according to a plan; allot: "The tendency persists to apportion blame as suits the circumstances" on a consolidated group basis. However, Sec. 864(e) and the Sec. 861 regulations provide exceptions to this general rule for certain expenses. Specifically, interest and expenses not directly allocable and apportioned to any specific income-producing activity (such as certain expenses relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc supportive functions, R&E expenses, stewardship expenses and legal and accounting expenses) must generally be allocated and apportioned as if all members of an affiliated group were a single corporation. (7) For this purpose, affiliated group has the same meaning as for consolidated return purposes under Sec. 1504 (without regard to Sec. 1504(b)(4)). However, Temp. Regs. Sec. 1.861-11T(d)(6) deems certain unaffiliated corporations (including certain foreign corporations) to be part of the affiliated group for interest expense allocation purposes.
In addition, for purposes of computing the DMD, Sec. 199(d)(4)(A) provides that all members of an expanded affiliated group (EAG EAG - Extended Affix Grammar ) are treated as a single corporation. For these purposes, all corporations in a consolidated group are treated as a single member. (8) An EAG is an affiliated group as defined in Sec. 1504(a), determined by substituting "more than 50%" for "at least 80%," and without regard to Sec. 1504(b)(2) and (4). (9) In addition, if all the interests in the capital and profits of a partnership are owned by members of a single EAG at all times during such partnership's tax year, the partnership and all members of such group are treated as a single taxpayer during such period. However, DPGR and deductions related to gross income attributable to DPGR are computed on an individual member basis. The QPAI of each member is then aggregated at the EAG level. The DMD is then determined at the EAG level and allocated among the members of the EAG in proportion to each member's QPAI.
Deductions Other than Those for which Specific Rules Are Provided
In all probability, the largest portion of most corporations' deductions consists of expenses other than R&E, interest and the other deductions specifically provided for in the Sec. 861 regulations. Salespeople's salaries, rent and bad debt expense are a few expenses that fall within this general category. Regs. Sec. 1.861-8 provides a two-step process in which these expenses are charged against gross income; first, expenses are allocated to the classes of gross income to which they are definitely related and, second, they are apportioned (within the class(es) of gross income) among statutory and residual groupings of gross income.
The regulations require allocating a deduction to the class of gross income to which it is definitely related. Under Regs. Sec. 1.861-8(b)(2), a deduction is definitely related if it is incurred as a result of, or incident to, the activity or property generating the class of gross income.
A class of gross income may consist of any one of several types of gross income, such as interest, sales or royalties; or it may consist of (1) more than one type of gross income (e.g., royalties and sales gross income or all gross income); or (2) subdivisions of one or more types of gross income (e.g., sales of a single product line as opposed to sales of all products). Regs. Sec. 1.861-8(b)(1) provides that the classes of gross income are not predetermined pre·de·ter·mine
v. pre·de·ter·mined, pre·de·ter·min·ing, pre·de·ter·mines
1. To determine, decide, or establish in advance: but must be ascertained as·cer·tain
tr.v. as·cer·tained, as·cer·tain·ing, as·cer·tains
1. To discover with certainty, as through examination or experimentation. See Synonyms at discover.
2. on the basis of the deductions to be allocated. Although most deductions will be definitely related to some class of a taxpayer's total gross income, some deductions are related to all gross income.
Once a deduction has been allocated to a class of gross income, it is necessary to apportion ap·por·tion
tr.v. ap·por·tioned, ap·por·tion·ing, ap·por·tions
To divide and assign according to a plan; allot: "The tendency persists to apportion blame as suits the circumstances" the deduction within the class of gross income to the statutory grouping (or to several statutory groupings) and to the residual grouping of gross income. If the entire class of gross income to which a deduction has been allocated is included in either the residual grouping or a single statutory grouping of gross income, there is no need to apportion that deduction, because the entire deduction is allocated to that respective grouping.
Apportionment must be accomplished in a manner that reflects, to a reasonably close extent, the factual relationship between the deduction and the gross income included in the class. In determining the apportionment method for a specific deduction, examples of bases and factors that may be used include a comparison of units sold, gross sales Gross Sales
A measure of overall sales that isn't adjusted for customer discounts or returns, calculated simply by adding all sales invoices, and not including operating expenses, cost of goods sold, payment of taxes, or any other charge. or receipts, COGs, profit contribution, expenses incurred, assets used, salaries paid, space used, and time spent attributable to the activities or properties giving rise to the class of gross income, and gross income amount.
For purposes of computing the Sec. 199 DMD, deductions should be apportioned between gross income attributable to DPGR and gross income attributable to non-DPGR, using methods that reasonably reflect the factual relationship between the expenses and the gross income included in the class of income. For example, if receipts from the sale of tangible property tangible property n. physical articles (things) as distinguished from "incorporeal" assets such as rights, patents, copyrights, and franchises. Commonly tangible property is called "personalty. include both DPGR and non-DPGR, the expenses of the marketing department overseeing such sales may be apportioned between gross income attributable to DPGR and gross income attributable to non-DPGR.
Regs. Sec. 1.861-8(f)(2) provides that when more than one operative section applies, taxpayers must use the same method of allocation and the same principles of apportionment for all operative sections. Thus, if a taxpayer is computing an FTC limitation and a DMD under Sec. 199, the taxpayer must be consistent with respect to the method of allocating and apportioning expenses. Further, while taxpayers have some latitude latitude, angular distance of any point on the surface of the earth north or south of the equator. The equator is latitude 0°, and the North Pole and South Pole are latitudes 90°N and 90°S, respectively. as to the different apportionment methods that may be used to apportion deductions within classes of gross income, they must ensure that the method chosen is reasonable and reflects, to a reasonably dose extent, the factual relationship between the deduction and the gross income.
Because the annual choice of an allocation or apportionment method does not affect the timing of recognition of income or expense, changing methods does not give rise to a change in accounting method under Sec. 446. (10)
Deductions with Specific Rules
Interest expense is subject to special rules under Sec. 864(e). Interest is generally allocable to all gross income on the theory that money is fungible A description applied to items of which each unit is identical to every other unit, such as in the case of grain, oil, or flour.
Fungible goods are those that can readily be estimated and replaced according to weight, measure, and amount. and that interest expense is attributable to all activities and property, regardless of any specific purpose for incurring in·cur
tr.v. in·curred, in·cur·ring, in·curs
1. To acquire or come into (something usually undesirable); sustain: incurred substantial losses during the stock market crash.
2. an obligation on which interest is paid. There are however specific exceptions for nonrecourse debt A nonrecourse debt or non-recourse debt or nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. , integrated financial transactions and the interest paid by a U.S. corporation when it also receives interest from a controlled foreign corporation Controlled foreign corporation (CFC)
A foreign corporation whose voting stock is more than 50% owned by US stockholders, each of whom owns at least 10% of the voting power. . (11)
Except for the special exceptions, the aggregate deductions for interest expense are considered to relate to all income-producing activities and assets of the taxpayer, and thus allocable to all of the gross income that the assets of the taxpayer generate, have generated or may reasonably be expected to generate. (12) Interest expense is then apportioned between statutory and residual groupings of gross income based on asset values. The Sec. 861 regulations require that taxpayers apportion interest expense to the various statutory groupings of gross income based on the average total value of the assets within each such grouping for the tax year, as determined under the asset valuation and asset characterization A rather long and fancy word for analyzing a system or process and measuring its "characteristics." For example, a Web characterization would yield the number of current sites on the Web, types of sites, annual growth, etc. rules. Thus, assets must be valued and characterized char·ac·ter·ize
tr.v. character·ized, character·iz·ing, character·iz·es
1. To describe the qualities or peculiarities of: characterized the warden as ruthless.
2. to determine the appropriate apportionment of interest expense under Sec. 864.
Valuation of assets: Taxpayers may elect to value assets on the basis of tax book value, alternative tax book value or fair market value (FMV FMV - full-motion video ). Temp. Regs. Sec. 1.861-9T(g) explains the tax book value and FMV methodologies and provides an election to allocate To reserve a resource such as memory or disk. See memory allocation. and apportion interest expense on the basis of either methods, (13) while Regs. Sec. 1.861-9(i) provides for the election of the alternative tax book value method. All methods require a determination of average asset values within each statutory grouping and the residual grouping computed for the year on the bases of the values of assets at the beginning and end of the year, unless such averaging results in a substantial distortion distortion, in electronics, undesired change in an electric signal waveform as it passes from the input to the output of some system or device. In an audio system, distortion results in poor reproduction of recorded or transmitted sound. of asset values (such as significant midyear mid·year
1. The middle of the calendar or academic year.
a. An examination given in the middle of a school year.
b. midyears A series of such examinations. acquisitions). (14)
Characterization of assets: Once assets have been valued under one of the three permissible per·mis·si·ble
Permitted; allowable: permissible tax deductions; permissible behavior in school.
per·mis methods, the assets are characterized according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. the source and type of the income that they generate, have generated or may reasonably be expected to generate. For purposes of characterization, assets are divided into three types:
1. Single category assets: Assets directly attributable to one statutory or residual grouping of gross income (e.g., assets used to produce DPGR income only);
2. Multiple category assets: Assets that generate income within more than one grouping of income (e.g., assets used to produce gross income attributable to DPGR and non-DPGR); or
3. Assets without directly identifiable yield: Assets that produce no directly identifiable income yield or that contribute equally to the generation of all the income of the taxpayer (e.g., assets used in general and administrative functions).
The Sec. 861 regulations have special rules for each category of assets. For example, as to the first category, no further apportionment will be necessary because single category assets are directly attributable to the relevant statutory or residual grouping of gross income. (15) In contrast, under Temp. Regs. Sec. 1.861-9T(g)(3), to attribute multiple category assets to the relevant groupings of income, the value of each asset is then prorated among the relevant groupings of income according to their respective proportions of gross income. Finally, the third category is not taken into account in determining the amount of interest expense apportioned to the statutory and residual groupings of gross income. Special rules governing gov·ern
v. gov·erned, gov·ern·ing, gov·erns
1. To make and administer the public policy and affairs of; exercise sovereign authority in.
2. the characterization of certain assets (such as stock and inventory) are provided in Temp. Regs. Sec. 1.861-12T.
AGs and EAGs: Sec. 864(e) and Temp. Regs. Secs. 1.861-9T(a) and -11T provide that, in general, interest expense of affiliated group (AG) members must be allocated and apportioned as if all members of the group were a single corporation. Interest expense of each AG member is apportioned based on the value of the combined AG assets generating gross income in a statutory grouping over the value of all the AG's assets as follows:
Value of AG assets generating income in statutory grouping (such as DPGR)/ Value of all AG assets x Interest expense The Sec. 199 proposed regulations provide that each EAG member is required to compute To perform mathematical operations or general computer processing. For an explanation of "The 3 C's," or how the computer processes data, see computer. its QPAI separately, (16) Thus, interest expense must be allocated and apportioned separately for each EAG member as follows:
Value of FAG member's assets generating DPGR/ Value of all member's assets x Interest expense
A consolidated group is considered a member of the EAG, and its interest expense is apportioned on a consolidated group basis. (17)
Under Sec. 864(g)(2), R&E expenses are the R&E expenditures deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). under Sec. 174. Although R&E expenses were historically allocated and apportioned under Regs. Sec. 1.861-8, Regs. Sec. 1.861-17 (issued in December 1995) now governs how R&E expenses are allocated under a multiple step process.
R&E expense undertaken to meet government standards is first directly allocated to the gross income derived from sources within the relevant geographic area. Other R&E expense is then allocated on the premise that R&E generally benefits all items of gross income (e.g., sales, royalties and dividends) reasonably connected with a broad product category (or categories). Such R&E expenses are allocated to a three-digit group enumerated This term is often used in law as equivalent to mentioned specifically, designated, or expressly named or granted; as in speaking of enumerated governmental powers, items of property, or articles in a tariff schedule. in the Standard Industrial Classification (SIC) Manual. Legally mandated R&E expense and other R&E expense are then apportioned using either the sales method or the optional gross income method. For nonlegally mandated R&E expenses, an exclusive geographical apportionment is required of a portion of the expense before it is subsequently apportioned based on either sales or gross income for most purposes. However, under the proposed Sec. 199 regulations, such exclusive geographic apportionment does not apply for purposes of calculating expenses under the Sec. 861 method when computing the DMD. (18)
Stewardship expenses arise from activities that a corporate shareholder undertakes for its own benefit to oversee its equity investments in related corporations. Expenses incurred in the overseeing function of the parent corporation typically represent a duplication duplication /du·pli·ca·tion/ (doo-pli-ka´shun)
1. the act or process of doubling, or the state of being doubled.
2. or review of activities and services already performed by the subsidiary corporation.
To the extent an activity of the parent corporation provides sufficient benefit to the operations of an affiliate, the corporation should charge a fee to the affiliate for the service. Additionally, even if the parent corporation does not charge its subsidiaries for such efforts, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. may impute impute v. 1) to attach to a person responsibility (and therefore financial liability) for acts or injuries to another, because of a particular relationship, such as mother to child, guardian to ward, employer to employee, or business associates. a service fee under Sec. 482. In either case, these nonduplicative expenses are attributable to the gross income derived from the service fees.
The title of the department performing corporate-type service does not control the characterization of the service. Thus, if a parent corporation has an international department or supervision department, the activities of these departments must nevertheless be examined to determine whether the expenses are in the nature of stewardship expenses, other supportive expenses, or expenses incurred to generate a fee or some other class of gross income. Additionally, other corporate supportive departments, such as personnel and marketing, should also be examined to determine whether any stewardship expenses are incurred.
Taxpayers should endeavor to distinguish stewardship expenses from other supportive expenses. Stewardship expenses are supportive expenses which specifically support dividend gross income. From a Sec. 199 perspective, stewardship expense should not be allocated against gross income attributable to DPGR because they are directly allocable to dividend income.
Exactly what constitutes a supportive expense is not dear. The Sec. 861 regulations list overhead, general and administrative expenses, and supervisory expenses as supportive in nature. Example (19) of Regs. Sec. 1.861-8(g) provides further guidance and includes the personnel department, training department, president's salary and sales manager's salary. Temp. Regs. Sec. 1.861-14T(e)(3) adds advertising, marketing and other sales expenses to this list.
Supportive expenses may be allocated in one of two ways: (1) initially to other deductions and then to the gross income to which the primary deductions are allocated; or (2) directly to all gross income or another broad class of gross income. Apportionment under the first method would follow the apportionment method used for the deductions to which the supportive functions expenses relate. Under the second method, supportive functions expenses are apportioned under the general Regs. Sec. 1.861-8 apportionment principles, based on the activities or property that generate, have generated or could reasonably be expected to generate gross income. In both cases, expenses related to supportive expenses are allocated and apportioned on an AG basis.
It is important to note that supportive expenses do not necessarily relate to all gross income. By allocating supportive expenses to a class of gross income narrower than all gross income, a more favorable fa·vor·a·ble
1. Advantageous; helpful: favorable winds.
2. Encouraging; propitious: a favorable diagnosis.
3. apportionment may be achieved for FTC limitation purposes. For example, assume a U.S. corporation manufactures and sells only within the U.S. and receives dividends from foreign subsidiaries. To the extent the corporation is able to demonstrate that its supportive expenses are related exclusively to its manufacturing and selling activities rather than to all its gross income, the expenses will be exclusively apportioned against U.S.-source income.
A taxpayer must keep in mind the interplay in·ter·play
Reciprocal action and reaction; interaction.
intr.v. in·ter·played, in·ter·play·ing, in·ter·plays
To act or react on each other; interact. of the FTC and the Sec. 199 deduction during the analysis. A taxpayer in an excess limit position may be less sensitive to reducing its foreign-source income as a by-product by·prod·uct or by-prod·uct
1. Something produced in the making of something else.
2. A secondary result; a side effect.
1. of increasing its DPGR. Accordingly, taxpayers should undertake a thorough analysis of their supportive expenses to determine whether a significant amount relates to a class of gross income consisting of less than all gross income.
Income taxes deducted de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. by a corporation, including state, municipal and foreign income taxes, are considered definitely related to the gross income on which such taxes are imposed. Although unclear in the past, state franchise tax that is computed based on the business activities (similar in nature to an income tax) within the state is also allocated in the same manner. The income on which the state income tax is imposed is determined by reference to the law of the jurisdiction imposing the tax.
The Sec. 861 regulations provide several examples of the application of these rules. Overall, the IRS applies a presumptive pre·sump·tive
1. Providing a reasonable basis for belief or acceptance.
2. Founded on probability or presumption.
pre·sump approach by assuming that all state taxable income in excess of the domestic-source income is foreign-source income. In addition, there are also two safe-harbor methodologies the taxpayer may use for allocating state tax.
Under Prop. Regs. Sec. 1.199-4(c)(2)(ii), NOLs are not allocated or apportioned against DPGR or gross income attributable to DPGR in calculating the Sec. 199 deduction. (19)
Losses on Certain Property Dispositions
The deduction allowed for recognized losses Recognized Loss
The amount of loss reported for income tax purposes.
You can defer recognizing some losses and then deduct the losses for the following year(s). on the sale, exchange or other disposition of a capital asset or property used in a trade or business is definitely related, and thus allocable to the class of gross income that such asset or property ordinarily or·di·nar·i·ly
1. As a general rule; usually: ordinarily home by six.
2. In the commonplace or usual manner: ordinarily dressed pedestrians on the street. generates in the hands of the taxpayer. When the property disposed dis·pose
v. dis·posed, dis·pos·ing, dis·pos·es
1. To place or set in a particular order; arrange.
2. of generated several types of income over several years, the Years, The
the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]
See : Time loss is allocated to the class of gross income generated by the property during the tax year or years immediately preceding the disposition.
For the Sec. 199 deduction, losses on the sale of property under Sec. 165 are allocated and apportioned to DPGR or gross income attributable to DPGR only if the proceeds from the sale are, or would have been, DPGR. (20)
Legal and Accounting Fees and Expenses
Fees and other expenses for legal and accounting services are ordinarily related and allocable to specific classes of gross income or to all the taxpayer's income, depending on the nature of the services rendered. For example, accounting fees for the preparation of a study to determine the costs involved in manufacturing a specific product will ordinarily be definitely related to the class of gross income derived from sales of that specific product, while a study of a corporate group's accounting information flow system will be definitely related to all gross income. Legal and accounting fees and expenses are allocated and apportioned on an affiliated-group basis.
Under Temp. Regs. Sec. 1.861-8T(e)(12), charitable contributions are generally considered as not definitely related to any gross income and thus must be apportioned between statutory and residual groupings of gross income based on the relative amount of gross income from sources within the U.S. in each grouping. Such apportionment entirely to U.S.-source income is generally beneficial to U.S. taxpayers because it generally increases the FTC limitation. A charitable contribution of any member of an affiliated group is allocated to all group members.
However, these rules do not apply for DMD purposes. For the Sec. 199 deduction, charitable contributions must be ratably apportioned between gross income attributable to DPGR and other gross income based on the relative amounts of gross income. (21)
The DRD is allocable to the dividend giving rise to the deduction. Accordingly, it will not be allocable to gross income attributable to DPGR for purposes of the DMD.
DMD For purposes of computing the FTC limitation, the DMD is allocable to DPGR that is U.S.-source income. The DMD may be apportioned between statutory and residual groupings within DPGR (e.g., rental income Noun 1. rental income - income received from rental properties
income - the financial gain (earned or unearned) accruing over a given period of time and sales income).
Other Sec. 199 Considerations
Special Rules for Certain Deductions
For purposes of computing QPAI, deductions allocable against gross income from DPGR do not include deductions not attributable to the conduct of a trade or business. (22) Also, note that if non-DPGR is treated as DPGR pursuant to the proposed Sec. 199 regulations, deductions related to such gross receipts that are deemed to be DPGR must be allocated and apportioned to gross income attributable to DPGR.
Sec. 861 Elections
Taxpayers are able to make certain elections under the Sec. 861 regulations. For example, a taxpayer may choose to determine the value of its assets on the basis of FMV, tax book value or alternative tax book value. (23) Some Sec. 861 elections necessitate ne·ces·si·tate
tr.v. ne·ces·si·tat·ed, ne·ces·si·tat·ing, ne·ces·si·tates
1. To make necessary or unavoidable.
2. To require or compel. IRS consent to revoke To annul or make void by recalling or taking back; to cancel, rescind, repeal, or reverse.
revoke v. to annul or cancel an act, particularly a statement, document, or promise, as if it no longer existed. or change to another method. (24) Because Sec. 199 requires certain taxpayers to use the roles of the Sec. 861 regulations in a new context, taxpayers may want to reconsider prior elections under those regulations. According to the preamble A clause at the beginning of a constitution or statute explaining the reasons for its enactment and the objectives it seeks to attain.
Generally a preamble is a declaration by the legislature of the reasons for the passage of the statute, and it aids in the interpretation of to the proposed Sec. 199 regulations, the IRS intends to issue a revenue procedure granting taxpayers automatic consent to change certain elections under the Sec. 861 regulations. The IRS and Treasury are requesting comments concerning such an automatic consent procedure, including which elections should be included and the appropriate time period during which the automatic consent should apply.
When fully phased in, the DMD will provide significant benefit to many taxpayers. These taxpayers must become familiar with the Sec. 861 allocation rules to make important decisions that will affect the DMD amount. Moreover, even when fully phased in, the DMD will yield a 9% deduction: the FTC is a credit that can reduce U.S. taxes dollar-for-dollar. Most taxpayers will not want to take positions that, while benefiting them for Sec. 199 purposes, might hurt their FTC limitation. Given the consistency requirements, taxpayers need to plan now to maximize their benefits under both provisions.
Author's note: The authors would like to thank Howard Berger for his contributions to this article.
Margie Rollinson, J.D.
International Tax Services Group
Ernst &Young LLP LLP - Lower Layer Protocol
Jill Schwieterman, LL.M LL.M Legum Magister (Master of Laws) .
International Tax Services Group
Ernst &Young LLP
Arlene Fitzpatrick, LL.B., LL.M.
International Tax Services Group
Ernst &Young LLP
Vickie Kraay, LL.B., LL.M.
International Tax Services Group
Ernst &Young LLP
(1) DPGR is defined as gross receipts received from (1) lease, rental, license, sale, exchange or other disposition of certain qualifying production property that is manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the U.S.; qualified film produced by the taxpayer; or electricity, natural gas or potable potable /pot·a·ble/ (po´tah-b'l) fit to drink.
Fit to drink; drinkable.
fit to drink. water produced by the taxpayer in the U.S.; (2) construction performed in the U.S.; or (3) engineering or architectural services performed in the U.S. for construction projects in the U.S. (Prop. Regs. Sec. 1.199-3(a)).
(2) See Prop. Regs. Sec. 1.199-4(e) and (f). The qualification requirements for both alternative methods under Notice 2005-14 are slightly different. According to the preamble of the proposed regulations, taxpayers may rely on the eligibility requirements under either the proposed Sec. 199 regulations or Notice 2005-14 until final regulations are published.
(3) See Prop. Regs. Sec. 1.199-4(c)(1).
(4) See Regs. Sec. 1.861-8(f)(1), which provides, in part, that the operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which give rise to statutory groupings to which this section is applicable include the overall limitation to the FTC, effectively connected taxable income, etc.
(5) See Prop. Regs. Sec. 1.199-4(d).
(6) See Regs. Sec. 1.861-8(a)(4), under which "statutory grouping" means the gross income from a specific source or activity that must first be determined to arrive at taxable income from such specific source or activity under an operative section. Gross income from other sources or activities is referred to as the "residual grouping of gross income" or "residual grouping."
(7) See Temp. Kegs. Secs. 1.861-11T(c) and -14T(c).
(8) See Regs. Sec. 1.199-7(d)(4).
(9) In the proposed Sec. 199 regulations, the Service is requesting comments regarding whether additional guidance is needed to clarify how the affiliated group roles in the Sec. 861 regulations apply under the Sec. 861 method to allocate and apportion interest and other expenses, such as R&E expenses, in computing QPAI of the members of such affiliated groups in which otherwise includible corporations are owned indirectly through foreign corporations and partnerships.
(10) Thus, for example, a taxpayer may change from using gross income as a factor to the use of units sold as a factor to apportion deductions, without such a change giving rise to a change in method of accounting under Sec. 446.
(11) These special rules, including the controlled foreign corporation netting rule, are outlined in Regs. Secs. 1.861-10 and Temp. Regs. Sec. 1.861-10T, but are not discussed further in this article.
(12) Sec. 864(e)(2) provides that all allocations and apportionments of interest expense must be made on the basis of asset values. For example, for purposes of computing the FTC limitation, interest expense is allocated to all gross income and must be apportioned in proportion to the value of the assets used to produce the various categories of foreign-source income and U.S.-source income. Similarly, under Sec. 199, interest expense must be apportioned in proportion to the value of assets used to produce gross income attributable to DPGR and gross income attributable to non-DPGR.
(13) See Temp. Kegs. Sec. 1.861-9T(g)(1)(ii).
(14) See Temp. Regs. Sec. 1.861-9T(g)(2)(2)(i).
(15) See Temp. Kegs. Sec. 1.861-9T(g)(3).
(16) See Prop. Regs. Sec. 1.199-7(a) and (b).
(17) See Prop. Regs. Sec. 1.199-7(d)(4).
(18) See Prop. Regs. Sec. 1.199-4(d)(3).
(19) Regs. Sec. 1.861-8(e)(8) provides that an NOL NOL - Never Offline deduction is allocated and apportioned in the same manner as the deductions giving rise to the NOL. Thus, an NOL deduction is definitely related and allocable to the class of gross income that generated the NOL. For FTC purposes, the loss is apportioned between the statutory and residual groupings of gross income on the basis of the relative amount of the NOL arising in the loss year, which is attributable to each of these groupings of income. The NOL retains its character when either it is carried back or carried forward.
(20) See Regs. Sec. 1.861-8(e)(7)(i).
(21) See Prop. Regs. Sec. 1.199-4(d)(2).
(22) See Prop. Regs. Sec. 1.199-4(c)(2)(iii).
(23) See Temp. Regs. Sec. 1.861-9T(g)(1)(ii).
(24) See Temp. Regs. Sec. 1.861-8T(c)(2), -9T(i)(2) and -17(e). For example, once a taxpayer uses the FMV to apportion interest expense, the taxpayer and all related persons must continue to use such method unless expressly authorized au·thor·ize
tr.v. au·thor·ized, au·thor·iz·ing, au·thor·iz·es
1. To grant authority or power to.
2. To give permission for; sanction: by the Commissioner.