Put Money in Your Pocket
by Rebecca St. Andrie

Often, making more money simply means keeping more of the money you already have. As March’s “Policy and Your Practice” article, “Don’t Leave Money on the Table,” pointed out, the tax code, applied correctly, can benefit O&P businesses. This month’s “Policy and Your Practice” takes a look at a tax policy that many O&P companies may not know about: section 199 of the Internal Revenue Code.

Section 199 of the Internal Revenue Code outlines a tax deduction that could benefit all AOPA members—suppliers and patient care facilities alike. Included as part of the 2004 American Jobs Creation Act, this deduction gives a tax break on taxable income related to “qualified production activities” conducted in the United States. 

AOPA members qualify, and the deduction is only going to grow. So read on to find out how to put more money in your pocket.

How much would you benefit?
The deduction, which went into effect starting in 2005, equals 3 percent of a business’s taxable income related to “the manufacture, production, growth, or extraction in whole or significant part in the United States of tangible personal property (e.g., clothing, goods and food.)”

Since O&P suppliers or patient care facilities provide “tangible personal property”—orthotics and prosthetics—they can claim this deduction.

There are many regulations involving the deduction, but here is a quick overview of how you might calculate your possible deduction. It is based on “taxable income,” which can be calculated in one of two ways. The deduction is based on the lesser of:

• Taxable income derived from a “qualified production activity,” or 

• Fifty percent of the W-2 wages paid during the calendar year.

What is taxable income?
Determining taxable income derived from a qualified production activity—the aforementioned “manufacture, production, growth, or extraction of tangible personal property”—follows this basic principle: Take gross receipts of product sales and subtract materials, labor, and other costs. This amount—the profit—is the “taxable income” the deduction is based on.

For example, imagine a patient care facility in the U.S. purchases various U.S.-made parts and materials to make a brace for $75. The facility incurs $25 in labor costs plus $2 in packaging and selling costs. If the facility receives $112 in reimbursement from Medicare for the brace, the deduction would be 3 percent of the facility’s $10 profit on the brace, or 30 cents. (.03 x ($112 - $75 - $25 - $2) = $0.30) This deduction would also work for suppliers.

Even if a patient care facility or supplier purchases the parts and materials from outside the U.S., the brace would be considered “manufactured…in significant part within the United States” if one of the two following conditions are met:

• The labor and overhead costs incurred by the business are at least 20 percent of the total cost; or

• Based on all of the facts and circumstances, the production performed by the business in the United States is substantial in nature.

Second-party activities
However, businesses that use central fabrication facilities need to understand some exceptions. Section 199 says that if one business performs manufacturing activities for another, only the business “with the benefits and burdens of ownership of the tangible personal property during the manufacturing process”—i.e., the central fabrication facility—will be treated as the manufacturer.

The W-2 wage method
As mentioned at the beginning of the article, the IRS can calculate the deduction either based on profits, as described above, or on W-2 wages. A business should declare its “taxable income” as 50 percent of W-2 wages, if that amount is less than calculating taxable income based on profit.

There are three methods for computing W-2 wages. The first method permits businesses to use the lesser amount of W-2 wages reported in Box 1 or Box 5 of the W-2 form. Alternatively, there are two methods that, although more complex, provide a more precise determination of W-2 wages. Details on these methods can be found at www.irs.gov.

It’s going to grow
Though the deduction for 2006 was 3 percent, in 2007 it is 6 percent. By 2010, the year the deduction is fully phased in, it will have increased to 9 percent.

So put some money in your pocket. While this article cannot cover all the intricacies of the U.S. tax code, these examples should show that Section 199 may offer a significant tax benefit for your business. Contact the IRS or your tax preparer to learn more.

Rebecca St. Andrie is managing editor of the O&P Almanac. Questions? Call (571) 431-0815.