United States

IRS issues regulations on the section 199 W-2 wage limitation

Wage limitation for acquisitions, dispositions and short years clarified

TAX ALERT  | 

On Aug. 27, 2015, the IRS issued final, temporary and proposed regulations relating to the allocation of W-2 wages for purposes of determining the wage limitation on a taxpayer's domestic production activities deduction allowed under section 199 (TD 9731 and REG-136459-09, respectively). The regulations primarily provide guidance on the allocation of W-2 wages paid by multiple employer taxpayers of the same employees during a calendar year and the determination the W-2 wages for taxpayers that have a short taxable year.

Section 199 was added to the Code by section 102 of the American Jobs Creation Act of 2004 and has been amended several times since its inception. Section 199 allows for a deduction equal to 9 percent of the lesser of:

  1. A taxpayer's qualified production activities income for the taxable year, or
  2. A taxpayer's taxable income as determined without regard to the deduction.

The deduction is also limited to 50 percent of the taxpayer's W-2 wages properly attributable to domestic production gross receipts for the taxable year.

Section 199(b)(3) provides that the Treasury Department shall generate guidance on the wage limitation rules in cases of a short taxable year or where a taxpayer acquires, or disposes of, a major portion of a trade or business, or a major portion of a separate unit of a trade or business during the taxable year. The guidance on this matter prior to these regulations taking effect is found in Rev. Proc. 2006-47, which provides that W-2 wages for a short taxable year can only include wages reported on Form W-2 for the calendar year ending with or within the short taxable year. The effect of this guidance resulted in a taxpayer with a short taxable year that did not include Dec. 31 having a W-2 wage limitation of zero.

The final, temporary and proposed regulations provide rules to address these concerns. In the case of an acquisition or disposition that results in multiple taxpayers being employers of employees of the acquired or disposed trade or business during a calendar year, the regulations provide that the W-2 wages paid during the calendar year to those employees are allocated between each taxpayer based on the period during which the employees were employed by that respective taxpayer. The regulations define an acquisition or disposition as an incorporation, formation, liquidation, reorganization, or a purchase or sale of assets. In the case of a short taxable year that does not include a calendar year end (Dec. 31), the regulations provide that the wages paid to employees during that time are treated as W-2 wages for that short taxable year and, thus, are includable in the section 199 wage limitation.

This guidance is helpful for taxpayers and the IRS alike because it resolves an unintended consequence of the existing guidance for computing the section 199 W-2 wage limitation for short taxable years. The new regulations provide guidance that has been alluded to and anticipated since the inception of section 199(b)(3).

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