A New Income Tax Deduction

Mr. Don Breece, Farm Management Specialist, OSU Extension Center at Lima

The American Jobs Creation Act of 2004 created a new domestic deduction based on income attributable to domestic production. Qualifying property includes receipts derived from what is grown or produced. This new deduction begins for the 2005 income tax year and is limited to the lesser of:

1. 3% of qualified production activities (QPAI),
2. 3% of taxable income of an entity or adjusted gross income for an individual taxpayer, or
3. 50% of W-2 wages paid during the year by the taxpayer.

Qualified production property for cash-basis farmers includes receipts for sales of livestock, produce, milk, grains, and other products raised by the farmer. Proceeds from the sale of raised breeding stock, reported on Farm 4797, also qualify. However, sales of purchased breeding or dairy animals will not qualify unless these were purchased as young stock and a substantial part of the animals value resulted from the farmers expense in raising the animal to maturity. Sales of land, machinery, and equipment are also excluded from domestic production gross receipts. Furthermore, custom hire is also excluded.

The 50% of W-2 wages limitation may become the most limiting factor for many farmers wishing to qualify for this deduction or wanting to take the maximum advantage of it.
One way to increase W-2 wages is to pay wages for unpaid family labor; however, the increase of FICA taxes and decrease in self-employment wages for the operator would need to be factored in as a result of this change. Also, note that the following wages are not included for the calculation of qualified wages:

1. Wages paid in commodities,
2. Wages paid to a child (under age 18) of the farmer, and
3. Compensation paid in non-taxable fringe benefits.

Although the domestic production activities deduction is limited to 3% of QPAI for tax years 2005 and 2006, it will be 6% for 2007 to 2009, and 9% for years after 2009. The tax form for this new deduction is Form 8903. See your income tax practitioner or the IRS web site at www.irs.gov for further information.