Monday, August 26, 2013

Tax Break for American Manufacturing of Gift Baskets

The section 199 "domestic production activities deduction" is a tax break for companies engaged in certain manufacturing and production activities in the United States, such as Detroit car manufacturers and Minnesota iron mining companies.  The tax break reduces the companies' tax rates by around 3%, after some complicated calculations and requirements.  The domestic production activities deduction is often complained about as a tax break for Big Oil, since the oil companies are entitled to the same tax break as other businesses.

In the landmark case of Dean v. Commissioner, 112 AFTR 2d (2013), the District Court for the Central District of California concluded that manufacturing includes the creation of gift baskets.

The case involved Houdini, Inc., a company that designs, assembles, and sells gift baskets.  Its 300 permanent employees and 4,000 seasonal employees select certain items, such as candy or wine, to make a gift basket.  The gift items, and the basket itself, are purchased in bulk from other companies in China and the United States.  Houdini's employees work in an assembly line in California to put the different items in the basket, and they plastic wrap the resulting basket with decorative bows. 

Treasury Regulation 1.199-3(e)(1) provides that manufacturing includes "making [property] by processing, manipulating, refining, or changing the form of an article."  The District Court concluded that Houdini's production process changed "the form of an article" because the assembly of the gift basket was a "complex production process" using assembly line workers and machines.  The company produced a final item (a gift) that was distinct in form and purpose from the individual items inside (groceries).  The company went beyond merely packaging or labeling a product, which by itself would not have counted as manufacturing.  Accordingly, the taxpayers (owners of Houdini, Inc.) were allowed to claim the section 199 domestic production activities deduction. 

In a separate matter, the Internal Revenue Service in field attorney advise memorandum 20133302F concluded that photo labs are engaged in manufacturing and production activities that qualify for the section 199 domestic production activities deduction.  The photo lab, located in a pharmacy, used its own equipment and "raw materials (the photo paper, ink and other chemicals) to produce a different tangible product in form and function -- finished photos or photo books sold to its customers."

Houdini Inc. and pharmacy photo labs may be considered prime examples of the American manufacturing renaissance.

Tuesday, August 20, 2013

Tax Break for Underwriters' Laboratories (UL)

Internal Revenue Code section 501(c)(3) provides a list of organization types that can qualify for non-profit status.  The non-profit has to be organized and operated exclusively for religious, charitable, educational, literary, or scientific purposes.  Or it can be an organization that does "testing for public safety" or works to "the prevention of cruelty to children or animals."

One would normally think that a non-profit organization would be considered "charitable," or at least "educational" or "scientific," if the non-profit tests products for product safety or prevents child or animal cruelty, without the need for the specific statutory language.  The "prevention of cruelty" provision was added to the Internal Revenue Code without explanation in 1918, perhaps at a time when people felt less charitable toward animals and children.

The product safety provision arose after the landmark 1943 case of Underwriters' Laboratories v. Commissioner.  Underwriters' Laboratories (UL) is the organization that provides the UL symbol on nearly all household electric products.  UL charges manufacturers an "ample fee" to test their products, and any approved products receive the UL label of approval.  UL keeps the fee even if the product is not approved.  Though UL was formed by various fire insurance companies, which are the members of UL, the members do not receive any of UL's profits.

The Seventh Circuit Court of Appeals concluded:
This does not sound like charity to us. If it is charity, it began at home. It was not the public interest that prompted the establishment of the petitioner. It was financial gain and business advantage. The primary concern of the petitioner was that of its membership, made up almost entirely of insurance companies, and the manufacturers who paid its ample fees. Whatever benefit inured to the public was only incidental to the primary concern.

 Congress changed the Internal Revenue Code in 1954 to specifically provide that UL and similar public safety testing organizations should be considered non-profits exempt from federal taxation.  However, the provision does not apply to drug testing organizations, because the testing to meet FDA requirements helps primarily the drug manufacturer rather than the general public.

Tuesday, August 6, 2013

Tax Break for Skydiving

The Internal Revenue Code contains several excise taxes on air transportation:
Section 4261(a) imposes a 7.5% excise tax on the amount paid for "domestic" air travel (in the United States or the parts of Canada and Mexico within 225 miles of the US border).
Section 4261(b) imposes a $3 excise tax for each segment of domestic air travel. 
Section 4261(c) imposes a $12 excise tax on international air travel that begins or ends in the United States.
Section 4271 imposes a 6.25% excise tax on the amount paid for the air transportation of freight.

The $3 and $12 are adjusted for inflation, and closer to $4 and $17 now.

Fortunately for the skydiving industry, section 4261(h) provides that none of the above taxes apply to any air transportation exclusively for the purposes of skydiving.  It does not matter whether or not skydiving instructions are provided to any of the passengers, as long as some passengers are diving off the plane.  

The Skydiving Exception was enacted by Congress in the Taxpayer Relief Act of 1997Prior to 1997, the taxation of skydiving flights was mixed, depending on whether the passengers were considered to be paying for commercial travel or for education. 

The use of the term "exclusively" means that an airline like Spirit Airlines cannot bundle a few skydivers with its flights to save on the excise taxes.  But a budding entrepreneur might consider starting a skydiving-only airline to provide some lower-cost tax-free transportation.