How can the DPAD help construction companies save?
The Domestic Production Activities Deduction (DPAD) is a term that every owner of a construction company should know. It is a free tax deduction that is allowed for any US company that produces goods. While this deduction is often called the manufacturer’s deduction, it truly is much broader than that. Not only do construction contractors qualify for this deduction, but so do those providing architecture and engineering services to construction contractors.
What is the DPAD?
Companies receive a phantom deduction equal to 9% of their net income from qualifying activities. This deduction can effectively lower the tax rate on this income by 3% for many taxpayers. It’s important to note that the 9% deduction does have various limitations, including that it must be less than 50% of a company’s wages or 9% of overall taxable income.
Although construction contractors surely qualify for the DPAD, not all of their activities qualify. If a contractor has a service department, the income derived from these service activities do not produce any DPAD. Likewise, the resale of products would not qualify for DPAD.
The requirement for a contractor to qualify for DPAD is that the activity is the construction of real property, and the term “construction of real property” is broadly defined. Construction may be related to residential or commercial buildings, other permanent structures or for land improvements. A range of activities qualify, from residential remodeling to HVAC and even some demolition. Companies doing international work must keep in mind that the DPAD only applies to projects located in the US.
As I stated early on, engineering and architecture services are also eligible for DPAD. It is only their activities, which are related to the construction of real property in the US, that are eligible. Many different activities related to these projects produce qualifying DPAD income, from the initial stages to design and include any ongoing supervision.
The actual calculation of the deduction can range from straightforward to complex. For example, if less than 5% of your company’s total receipts are from non-qualified activities, 100% of your taxable income is treated as qualifying. On the other hand, if more than 5% of your company’s receipts are non-qualifying, you need to establish a calculation that follows one of the rules provided in the regulations to Internal Revenue Code Section 199 (the DPAD section).
An example of the DPAD
If your company is not currently taking the DPAD and you have qualifying activities, then you are missing a huge opportunity. Take a look at the impact of this deduction in the example below.
Comparison of an architecture firm providing services that are 96% qualifying activities, with and without taking the DPAD.
|Without the DAPD||With the DPAD|
|Adjusted Taxable Income||800,000||728,000|
|Federal Tax (40%)||320,000||291,200|
The limitations, rules, and compliance requirements have deterred some from taking the DPAD deduction. This is where we can help. Contact the construction accounting experts at MKS&H to see if you are eligible for the DPAD. We’ll provide the direction and assistance that allows you to take the full deduction allotted to your organization.