Regulations Determine Allocation of Wages for Domestic Production Activities Deduction

New temporary and proposed regulations provide guidance on how two or more taxpayers that are employers of the same employees during a calendar year should allocate the W-2 wages that were paid for purposes of the Sec. 199 domestic production activities deduction and how to determine W-2 wages if the taxpayer has a short tax year (T.D. 9731; REG-136459-09).

Under Sec. 199(b)(1), the amount of the domestic activities production deduction allowed for any tax year cannot exceed 50% of the taxpayer’s W-2 wages for the tax year. W-2 wages are defined, for any person for that person’s tax year, as the sum of amounts described in Secs. 6051(a)(3) and (8) (the total wages subject to income tax withholding and deferred compensation) paid by that person for the employment of employees by that person during the calendar year ending during that tax year.

Last year, the Tax Increase Prevention Act of 2014, P.L. 113-295, amended Sec. 199(b)(3) to require the IRS to provide rules to apply Sec. 199(b) in cases where a taxpayer has a short tax year or acquires, or disposes of, the major portion of a trade or business, or the major portion of a separate unit of a trade or business, during the tax year.

The temporary regulations revise the current version of these rules. Specifically, the temporary regulations provide a rule for acquisitions and dispositions if one or more taxpayers may be considered the employer of the employees of the acquired or disposed of trade or business during that calendar year. In that case, the temporary regulations provide that the W-2 wages paid during the calendar year to employees of the acquired or disposed of trade or business are allocated between each taxpayer based on the period during which the employees of the acquired or disposed of trade or business were employed by the taxpayer. An acquisition or disposition includes an incorporation, a formation, a liquidation, a reorganization, or a purchase or sale of assets.

In addition, the current Regs. Sec. 1.199-2(e)(1) provides that the term “W-2 wages” means, for any person for any tax year of that person, the sum of the amounts described in Secs. 6051(a)(3) and (8) paid by that person for employment of employees by that person during the calendar year ending during that tax year.

However, in some cases, a short tax year may not include a calendar year ending within a short tax year, and the current rules do not address that situation. So, in the case of a short tax year in which there is no calendar year ending within that short tax year, the new rules provide that wages paid by a taxpayer during the short tax year to employees for employment by such taxpayer are treated as W-2 wages for that short tax year under Sec. 199(b)(1).

The regulations are effective Aug. 27, 2015, the date they are published in the Federal Register. Taxpayers may apply them retroactively to tax years for which the statute of limitation has not expired as of Aug. 27, 2015.

—Sally P. Schreiber (sschrieber@aicpa.org) is a Tax Adviser senior editor.