SECTION 2. OVERVIEW OF § 199

.01 In General. (1) Section 199(a)(1) allows a deduction equal to 9 percent (3 percent in the case of taxable years beginning in 2005 and 2006, and 6 percent in the case of taxable years beginning in

2007, 2008, or 2009) of the lesser of (a) the qualified production activities income (QPAI) of the taxpayer for the taxable year, or (b) taxable income (determined without regard to § 199) for the taxable year (or, in the case of an individual, under § 199(d)(2), adjusted gross income).

(2) Section 199(b)(1) limits the deduction for a taxable year to 50 percent of the W–2 wages paid by the taxpayer during the calendar year that ends in such taxable year. For this purpose, § 199(b)(2) defines the term “W–2 wages” to mean the sum of the aggregate amounts the taxpayer is required under § 6051(a)(3) and (8) to include on the Forms W–2 of the taxpayer’s employees during the calendar year ending during the taxpayer’s taxable year. Section 199(b)(3) provides that the Secretary shall prescribe rules for the application of § 199(b) in the case of an acquisition or disposition of a major portion of either a trade or business or a separate unit of a trade or business during the taxable year.

.02 Qualified Production Activities In- come . (1) Under § 199(c)(1), QPAI is the excess of domestic production gross receipts (DPGR) over the sum of: (a) the cost of goods sold (CGS) allocable to such receipts; (b) other deductions, expenses, or

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the taxable income of the cooperative under § 1382.

(2) In determining the portion of the cooperative’s QPAI that would be deductible by the cooperative, the cooperative’s taxable income is computed without taking into account any deduction allowable under § 1382(b) or (c) (relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions) and, in the case of a cooperative engaged in marketing agricultural and horticultural products, the cooperative is treated as having MPGE, in whole or in significant part, any QPP marketed by the cooperative that its patrons have MPGE.

.06 Expanded Affiliated Groups . (1) Section 199(d)(4)(A) provides that all members of an expanded affiliated group (EAG) are treated as a single corporation for purposes of § 199. Section 199(d)(4)(B) provides that an EAG is an affiliated group as defined in § 1504(a), determined by substituting “50 percent” for “80 percent” each place it appears, and without regard to § 1504(b)(2) and (4).

(2) Section 199(d)(4)(C) provides that, except as provided in regulations, the § 199 deduction is allocated among the members of the EAG in proportion to each member’s respective amount (if any) of QPAI.

.07 Trade or Business Requirement . Section 199(d)(5) provides that § 199 is applied by taking into account only items that are attributable to the actual conduct of a trade or business.

.08 Alternative Minimum Tax . Section 199(d)(6) provides rules to coordinate the deduction allowed under § 199 with the alternative minimum tax (AMT) imposed by § 55. The deduction is allowed for purposes of the AMT, except that the deduction is equal to the applicable percent of the lesser of the taxpayer’s: (1) QPAI, determined without regard to subchapter A, Part IV, of the Code; or (2) alternative minimum taxable income (AMTI). For purposes of the preceding sentence, in the case of an individual, AGI (determined without regard to § 199) shall be substituted for AMTI.

.09 Authority to Prescribe Regulations . Section 199(d)(7) authorizes the Secretary to prescribe such regulations as are necessary to carry out the purposes of § 199.

tion of (i) qualifying production property (QPP) that was manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or in significant part within the United States; (ii) any qualified film produced by the taxpayer; or (iii) electricity, natural gas, or potable water produced by the taxpayer in the United States; (b) construction performed in the United States; or (c) engineering or architectural services performed in the United States for construction projects in the United States. Section 199(c)(4)(B) excepts from DPGR gross receipts of the taxpayer that are derived from: (a) the sale of food and beverages prepared by the taxpayer at a retail establishment; and (b) the transmission or distribution of electricity, natural gas, or potable water.

(5) Section 199(c)(5) defines QPP to mean: (a) tangible personal property; (b) any computer software; and (c) any property described in § 168(f)(4) (certain sound recordings).

(6) Section 199(c)(6) defines a qualified film to mean any property described in § 168(f)(3) if not less than 50 percent of the total compensation relating to production of the property is compensation for services performed in the United States by actors, production personnel, directors, and producers. The term does not include property with respect to which records are required to be maintained under 18 U.S.C. § 2257 (generally, films, videotapes, or other matter that depict actual sexually explicit conduct and are produced in whole or in part with materials that have been mailed or shipped in interstate or foreign commerce, or are shipped or transported or are intended for shipment or transportation in interstate or foreign commerce).

(7) Section 199(c)(7) provides that DPGR does not include any gross receipts of the taxpayer derived from property leased, licensed, or rented by the taxpayer for use by any related person. A person is treated as related to another person if both persons are treated as a single employer under either § 52(a) or (b) (without regard to § 1563(b)), or § 414(m) or (o).

.03 Pass-thru Entities . (1) Section 199(d)(1) provides that, in the case of an S corporation, partnership, estate or trust, or other pass-thru entity, § 199 generally is applied at the shareholder,

partner, or similar level, except as otherwise provided in rules applicable to individuals and patrons of cooperatives. Section 199(d)(1) further provides that the Secretary shall prescribe rules for the application of § 199, including rules relating to: (a) restrictions on the allocation of the deduction to taxpayers at the partner or similar level; and (b) additional reporting requirements.

(2) Notwithstanding the general rule that § 199 is applied at the shareholder, partner, or similar level, § 199(d)(1)(B) provides that, for purposes of applying the wage limitation of § 199(b), a shareholder, partner, or similar person that is allocated QPAI from an S corporation, partnership, estate, trust, or other pass-thru entity is also treated as having been allocated W–2 wages from such entity in an amount equal to the lesser of: (i) such person’s allocable share of such wages (without regard to this rule) as determined under regulations prescribed by the Secretary; or (ii) 2 times 9 percent (3 percent in the case of taxable years beginning in 2005 and 2006, and 6 percent in the case of taxable years beginning in 2007, 2008, or 2009) of the QPAI allocated to such person for the taxable year.

.04 Individuals . In the case of individuals, § 199(d)(2) provides that the deduction is equal to the applicable percent of the lesser of the taxpayer’s (1) QPAI for the taxable year, or (2) adjusted gross income (AGI) for the taxable year determined after applying §§ 86, 135, 137, 219, 221, 222, and 469, and without regard to § 199.

.05 Patrons of Certain Cooperatives . (1) Section 199(d)(3) provides special rules under which a taxpayer receiving certain patronage dividends or certain qualified per-unit retain allocations from a cooperative (to which subchapter T applies) engaged in the MPGE, in whole or in significant part, or in the marketing, of any agricultural or horticultural product is allowed a deduction under § 199 with respect to the amount of the patronage dividends or qualified per-unit retain allocations that are: (a) allocable to the portion of the cooperative’s QPAI that would be deductible by the cooperative; and (b) designated as such by the cooperative in a written notice mailed to its patrons during the payment period described in § 1382. Such an amount, however, does not reduce

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taxpayer’s W–2 wages under § 199(b)(2) the lesser of (A) the total entries in Box 1 of all Forms W–2 filed with the Social Security Administration (SSA) by the taxpayer with respect to employees of the taxpayer or (B) the total entries in Box 5 of all Forms W–2 filed with the SSA by the taxpayer with respect to employees of the taxpayer. Under the second option, the W–2 wages are calculated by subtracting from the total amounts reported in Box 1 of Forms W–2 with respect to employees of the taxpayer (1) amounts that are included in Box 1 that are not wages under § 3401(a) and (2) items that are treated as wages under § 3402(o) (for example, supplemental unemployment compensation benefits), and then adding those elective deferrals that are reported in Box 12 of Forms W–2 with Codes D, E, F, G, and S. Under the third option, a taxpayer may track the actual amount of wages subject to federal income tax withholding, subtract supplemental unemployment compensation benefits that were included in this amount, and then add specific elective deferrals that are reported in Box 12 of Forms W–2 with Codes D, E, F, G, and S.

.03 Determining Qualified Production Activities Income . Section 4.03 of this notice provides rules for determining a taxpayer’s QPAI for the taxable year. This notice provides that QPAI is determined on an item-by-item basis (and not, for example, on a division-by-division, a product line-by-product line, or a transactionby-transaction basis) and is the sum of the QPAI derived by the taxpayer from each item. For purposes of this determination, QPAI from each item may be positive or negative. Section 4.04 provides rules for determining a taxpayer’s DPGR, the definition of the terms “gross receipts,” “manufactured, produced, grown, or extracted,” “by the taxpayer,” “in whole or in significant part,” and “derived from the lease, rental, license, sale, exchange, or other disposition of qualifying production property,” as well as rules for determining whether property qualifies as QPP (that is, tangible personal property, computer software, and sound recordings). See section 3.04 for an explanation of these rules. Section 4.05 provides rules for determining a taxpayer’s costs (including CGS) for purposes of computing QPAI. See section 3.05 for an explanation of the rules relating to costs. Generally, if a taxpayer is