[Federal Register Volume 72, Number 1 (Wednesday, January 3, 2007)]
[Rules and Regulations]
[Pages 5-7]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-22019]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9263]
RIN 1545-BE33


Income Attributable to Domestic Production Activities; Correction

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Correcting amendment.

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SUMMARY: This document contains corrections to final regulations which 
were published in the Federal Register on Thursday, June 1, 2006, (71 
FR 31268), relating to the deduction for income attributable to 
domestic production activities under section 199 of the Internal 
Revenue Code (Code).

DATES: This correction is effective June 1, 2006.

FOR FURTHER INFORMATION CONTACT: Paul Handleman or Lauren Ross Taylor 
at (202) 622-3040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    The final regulations (TD 9263) that are subject to this correction 
are under section 199 of the Internal Revenue Code.

Need for Correction

    On June 1, 2006, final regulations (TD 9263) were published in the 
Federal Register at 71 FR 31268. These regulations contain errors that 
may prove to be misleading and are in need of clarification.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Correction of Publication

0
Accordingly, 26 CFR Part 1 is corrected by making the following 
correcting amendments:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805 * * *


Sec.  1.199-1  [Corrected]

0
Par. 2. Section 1.199-1(b)(1) is amended by revising the first sentence 
of the paragraph to read as follows:


Sec.  1.199-1  Income attributable to domestic production activities.

* * * * *
    (b) * * *
    (1) In general. For purposes of paragraph (a) of this section, the 
definition of taxable income under section 63 applies, except that 
taxable income (or alternative minimum taxable income, if applicable) 
is determined without regard to section 199 and without regard to any 
amount excluded from gross income pursuant to section 114 or pursuant 
to section 101(d) of the American Jobs Creation Act of 2004, Public Law 
108-357 (118 Stat. 1418) (Act). * * *
* * * * *


Sec.  1.199-2  [Corrected]

0
Par. 3. Section 1.199-2 is amended by revising the first sentence of 
paragraph (a)(3)(ii) and the last sentence of paragraph (e)(3) to read 
as follows:


Sec.  1.199-2  Wage limitation.

    (a) * * *
    (3) * * *
    (ii) Corrected return filed to correct a return that was filed 
within 60 days of the due date. If a corrected information return 
(Return B) is filed with SSA on or before the 60th day after the due 
date (including extensions) of Return B to correct an information 
return (Return A) that was filed with SSA on or before the 60th day 
after the due date (including extensions) of the information return 
(Return A) and paragraph (a)(3)(iii) of this section does not apply, 
then the wage information on Return B must be included in determining 
W-2 wages.* * *
* * * * *
    (e) * * *
    (3) * * * For example, see Rev. Proc. 2006-22 (2006-23 I.R.B. 
1033). (see Sec.  601.601(d)(2) of this chapter).


Sec.  1.199-3  [Corrected]

0
Par. 4. Section 1.199-3(l)(4)(iv)(A) is amended by revising the first 
sentence of the paragraph to read as follows:


Sec.  1.199-3  Domestic production gross receipts.

* * * * *
    (l) * * *
    (4) * * *
    (iv) * * *
    (A) * * * DPGR. Notwithstanding paragraphs (l)(4)(i), (ii), and 
(iii) of this section, if less than 5 percent of a taxpayer's gross 
receipts derived from a sale, exchange, or other disposition of 
utilities are attributable to the transmission or distribution of the 
utilities and the storage of potable water after completion of 
treatment of the potable water, then the gross receipts derived from 
the lease, rental, license, sale, exchange, or other disposition of the 
utilities that are attributable to the transmission and distribution of 
the utilities and the storage of potable water after completion of 
treatment of the potable water may be treated as being DPGR (assuming 
all other requirements of this section are met). * * *
* * * * *


Sec.  1.199-4  [Corrected]

0
Par. 5. Section 1.199-4(d)(6) is amended by revising paragraph
    (i) of Examples 1 and 2 to read as follows:


Sec.  1.199-4  Costs allocable to domestic production gross receipts.

* * * * *
    (d) * * *
    (6) * * *

    Example 1. * * *
    (i) Facts. X, a United States corporation that is not a member 
of an expanded affiliated group (EAG) (as defined in Sec.  1.199-7), 
engages in activities that generate both DPGR and non-DPGR. All of 
X's production activities that generate DPGR are within Standard 
Industrial Classification (SIC) Industry Group AAA (SIC AAA). All of 
X's production activities that generate non-DPGR are within SIC 
Industry Group BBB (SIC BBB). X is able to specifically identify CGS 
allocable to DPGR and to non-DPGR. X incurs $900 of research and 
experimentation expenses (R&E) that are deductible under section 
174, $300 of which are performed with respect to SIC AAA and $600 of 
which are performed with respect to SIC BBB. None of the R&E is 
legally mandated R&E as described in Sec.  1.861-17(a)(4) and none 
of the R&E is included in CGS. X incurs section 162 selling expenses 
that are not includible in CGS and are definitely related to all of 
X's gross income. For 2010, the adjusted basis of X's assets is 
$5,000, $4,000 of which generates gross income attributable to DPGR 
and $1,000 of which generates gross income attributable to non-DPGR. 
For 2010, X's taxable income is $1,380 based on the following 
Federal income tax items: * * *
* * * * *
    Example 2. * * *
    (i) Facts. The facts are the same as in Example 1 except that X 
owns stock in Y, a United States corporation, equal to 75% of the 
total voting power of stock of Y and 80% of the total value of stock 
in Y. X and Y are

[[Page 6]]

not members of an affiliated group as defined in section 1504(a). 
Accordingly, the rules of Sec.  1.861-14T do not apply to X's and 
Y's selling expenses, R&E, and charitable contributions. X and Y 
are, however, members of an affiliated group for purposes of 
allocating and apportioning interest expense (see Sec.  1.861-
11T(d)(6)) and are also members of an EAG. For 2010, the adjusted 
basis of Y's assets is $45,000, $21,000 of which generates gross 
income attributable to DPGR and $24,000 of which generates gross 
income attributable to non-DPGR. All of Y's activities that generate 
DPGR are within SIC Industry Group AAA (SIC AAA). All of Y's 
activities that generate non-DPGR are within SIC Industry Group BBB 
(SIC BBB). None of X's and Y's sales are to each other. Y is not 
able to specifically identify CGS allocable to DPGR and non-DPGR. In 
this case, because CGS is definitely related under the facts and 
circumstances to all of Y's gross receipts, apportionment of CGS 
between DPGR and non-DPGR based on gross receipts is appropriate. 
For 2010, Y's taxable income is $1,910 based on the following 
Federal income tax items: * * *
* * * * *


Sec.  1.199-6  [Corrected]

0
Par. 6. Section 1.199-6 is amended as follows:
0
1. The last sentence of paragraph (g), is revised.
0
2. The last sentence of Example 2 (i) in paragraph (m) is revised.
    The revisions read as follows:


Sec.  1.199-6  Agricultural and horticultural cooperatives.

* * * * *
    (g) Written notice to patrons. * * * The cooperative must report 
the amount of the patron's section 199 deduction on Form 1099-PATR, 
``Taxable Distributions Received From Cooperatives,'' issued to the 
patron.
* * * * *
    (m) * * *

    Example 2. (i) * * * Cooperative X must report the amount of 
Patron A's section 199 deduction on Form 1099-PATR, ``Taxable 
Distributions Received From Cooperatives,'' issued to Patron A for 
the calendar year 2008.

* * * * *


Sec.  1.199-7  [Corrected]

0
Par. 7. Section 1.199-7 is amended as follows:
0
1. Example 3 in paragraph (a)(4) is revised.
0
2. Example 10 in paragraph (e) is revised.
    The revisions read as follows:


Sec.  1.199-7  Expanded affiliated groups.

    (a) * * *
    (4) * * *

    Example 3. The facts are the same as in Example 2 except that 
rather than reselling the machinery, B rents the machinery to 
unrelated persons and B takes the gross receipts attributable to the 
rental of the machinery into account under its methods of accounting 
in 2007, 2008, and 2009. In addition, as of the close of business on 
December 31, 2008, A and B cease to be members of the same EAG. With 
respect to the machinery acquired from C and the unrelated persons, 
B's gross receipts attributable to the rental of the machinery in 
2007, 2008, and 2009 are non-DPGR because no member of the EAG MPGE 
the machinery and because C does not qualify as an EAG partnership. 
With respect to machinery acquired from A, B's gross receipts in 
2007 and 2008 attributable to the rental of the machinery are DPGR 
because at the time B takes into account the gross receipts derived 
from the rental of the machinery under its methods of accounting, B 
is a member of the same EAG as A and B is treated as conducting A's 
previous MPGE activities. However, with respect to the rental 
receipts in 2009, because A and B are not members of the same EAG in 
2009, B's rental receipts are non-DPGR.
* * * * *
    (e) * * *

    Example 10. (i) Facts. Corporation P owns all of the stock of 
Corporations S and T, and P, S, and T file a consolidated Federal 
income tax return on a calendar year basis. In 2007, P MPGE QPP in 
the United States at a cost of $1,000. On November 30, 2007, P sells 
the QPP to S for $2,500. On February 28, 2008, P disposes of 60% of 
the stock of S. On June 30, 2008, S sells the QPP to an unrelated 
person for $3,000.
* * * * *


Sec.  1.199-8  [Corrected]

0
Par. 8. Section 1.199-8 is amended by revising paragraph (h) to read as 
follows:


Sec.  1.199-8  Other rules.

* * * * *
    (h) Disallowed losses or deductions. Except as provided by 
publication in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter), losses or deductions of a 
taxpayer that otherwise would be taken into account in computing the 
taxpayer's section 199 deduction are taken into account only if and to 
the extent the deductions are not disallowed by section 465 or 469, or 
any other provision of the Code. If only a portion of the taxpayer's 
share of the losses or deductions is allowed for a taxable year, the 
proportionate share of those allowable losses or deductions that are 
allocated to the taxpayer's qualified production activities, determined 
in a manner consistent with sections 465 and 469, and any other 
applicable provision of the Code, is taken into account in computing 
QPAI for purposes of the section 199 deduction for that taxable year. 
To the extent that any of the disallowed losses or deductions are 
allowed in a later year, the taxpayer takes into account a 
proportionate share of those losses or deductions in computing it QPAI 
for that later taxable year. Losses or deductions of the taxpayer that 
are disallowed for taxable years beginning on or before December 31, 
2004, are not taken into account in a later year for purposes of 
computing the taxpayer's QPAI and the wage limitation of section 
199(d)(1)(A)(iii) under Sec.  1.199-9 for that taxable year, regardless 
of whether the losses or deductions are allowed for other purposes. For 
taxpayers that are partners in partnerships, see Sec.  1.199-9(b)(2). 
For taxpayers that are shareholders in S corporations, see Sec.  1.199-
9(c)(2).
* * * * *


Sec.  1.199-9  [Corrected]

0
Par. 9. Section 1.199-9(b)(6) is amended as follows:
0
1. By revising Example 1 paragraphs (i), (iii)(B)(1), and the seventh 
sentence of (iii)(B)(2).
0
2. By revising Example 2 paragraphs (i), and (iii)(B)(1), and the table 
following (iii)(B)(3).
0
3. Paragraph (h) is revised.
    The revisions read as follows:


Sec.  1.199-9  Application of section 199 to pass-thru entities for 
taxable years beginning on or before May 17, 2006, the enactment date 
of the Tax Increase Prevention and Reconciliation Act of 2005.

* * * * *
    (b) * * *
    (6) * * *
    Example 1. * * * (i) Partnership Federal income tax items. X and 
Y, unrelated United States corporations, are each 50% partners in 
PRS, a partnership that engages in production activities that 
generate both DPGR and non-DPGR. X and Y share all items of income, 
gain, loss, deduction, and credit 50% each. Both X and Y are engaged 
in a trade or business. PRS is not able to specifically identify CGS 
allocable to DPGR and non-DPGR. In this case, because CGS is 
definitely related under the facts and circumstances to all of PRS's 
gross income, apportionment of CGS between DPGR and non-DPGR based 
on gross receipts is appropriate. For 2006, the adjusted basis of 
PRS's business assets is $5,000, $4,000 of which generate gross 
income attributable to DPGR and $1,000 of which generate gross 
income attributable to non-DPGR. For 2006, PRS has the following 
Federal income items: * * *
* * * * *
    (iii) * * *
    (B) * * * (1) For 2006, in addition to the activities of PRS, Y 
engages in production activities that generate both DPGR and non-
DPGR. Y is able to specifically identify CGS allocable to DPGR and 
to non-DPGR. For 2006, the adjusted basis of Y's non-PRS assets 
attributable to its production activities that generate DPGR is 
$8,000 and to other

[[Page 7]]

production activities that generate non-DPGR is $2,000. Y has no 
other assets. Y has the following Federal income tax items relating 
to its non-PRS activities: * * *
    (2) * * * Y has $1,290 of gross income attributable to DPGR 
($3,000 DPGR ($1,500 from PRS and $1,500 from non-PRS activities)--
$1,710 CGS ($810 from PRS and $900 from non-PRS activities)). * * *
* * * * *
    Example 2. * * * (i) Partnership items of income, gain, loss, 
deduction or credit. X and Y, unrelated United States corporations 
each of which is engaged in a trade or business, are partners in 
PRS, a partnership that engages in production activities that 
generate both DPGR and non-DPGR. Neither X nor Y is a member of an 
affiliated group. X and Y share all items of income, gain, loss, 
deduction, and credit 50% each. All of PRS's domestic production 
activities that generate DPGR are within Standard Industrial 
Classification (SIC) Industry Group AAA (SIC AAA). All of PRS's 
production activities that generate non-DPGR are within SIC Industry 
Group BBB (SIC BBB). PRS is not able to specifically identify CGS 
allocable to DPGR and to non-DPGR and, therefore, apportions CGS to 
DPGR and non-DPGR based on its gross receipts. PRS incurs $900 of 
research and experimentation expenses (R&E) that are deductible 
under section 174, $300 of which are performed with respect to SIC 
AAA and $600 of which are performed with respect to SIC BBB. None of 
the R&E is legally mandated R&E as described in Sec.  1.861-17(a)(4) 
and none is included in CGS. PRS incurs section 162 selling expenses 
(that include W-2 wage expense) that are not includible in CGS and 
are definitely related to all of PRS's gross income. For 2006, PRS 
has the following Federal income tax items: * * *
* * * * *
    (iii) * * *
    (B) * * * (1) For 2006, in addition to the activities of PRS, Y 
engages in domestic production activities that generate both DPGR and 
non-DPGR. With respect to those non-PRS activities, Y is not able to 
specifically identify CGS allocable to DPGR and to non-DPGR. In this 
case, because CGS is definitely related under the facts and 
circumstances to all of Y's non-PRS gross receipts, apportionment of 
CGS between DPGR and non-DPGR based on Y's non-PRS gross receipts is 
appropriate. For 2006, Y has the following non-PRS Federal income tax 
items: * * *
* * * * *
    (3) * * *

------------------------------------------------------------------------
 
------------------------------------------------------------------------
DPGR ($4,500 DPGR ($1,500 from PRS and $3,000 from                $4,500
 non-PRS activities))................................
CGS ($600 from sales of products by PRS and $1,500               (2,100)
 from non-PRS activities)............................
Section 162 selling expenses (including W-2 wages)                 (480)
 ($420 from PRS + $540 from non-PRS activities) x
 ($4,500 DPGR/$9,000 total gross receipts)...........
Section 174 R&E-SIC AAA ($150 from PRS and $300 from               (450)
 non-PRS activities).................................
Section 174 R&E-SIC BBB ($300 from PRS + $450 from                 (188)
 non-PRS activities) x ($1,500 DPGR/$6,000 total
 gross receipts allocated to SIC BBB ($1,500 from PRS
 and $4,500 from non-PRS activities))................
                                                      ------------------
  Y's QPAI...........................................              1,282
------------------------------------------------------------------------

* * * * *
    (h) * * * Except as provided in paragraph (i) of this section 
regarding qualifying in-kind partnerships and paragraph (j) of this 
section regarding EAG partnerships, an owner of a pass-thru entity is 
not treated as conducting the qualified production activities of the 
pass-thru entity, and vice versa. This rule applies to all 
partnerships, including partnerships that have elected out of 
subchapter K under section 761(a). Accordingly, if a partnership MPGE 
QPP within the United States, or produces a qualified film or produces 
utilities in the United States, and distributes or leases, rents, 
licenses, sells, exchanges, or otherwise disposes of such property to a 
partner who then, without performing its own qualifying MPGE or other 
production, leases, rents, licenses, sells, exchanges, or otherwise 
disposes of such property, then the partner's gross receipts from this 
latter lease, rental, license, sale, exchange, or other disposition are 
treated as non-DPGR. In addition, if a partner MPGE QPP within the 
United States, or produces a qualified film or produces utilities in 
the United States, and contributes or leases, rents, licenses, sells, 
exchanges, or otherwise disposes of such property to a partnership 
which then, without performing its own qualifying MPGE or other 
production, leases, rents, licenses, sells, exchanges, or otherwise 
disposes of such property, then the partnership's gross receipts from 
this latter disposition are treated as non-DPGR.
* * * * *

Guy R. Traynor,
Federal Register Liaison, Legal Processing Division, Associate Chief 
Counsel (Procedure & Administration).
 [FR Doc. E6-22019 Filed 12-29-06; 8:45 am]
BILLING CODE 4830-01-P