The IRS does not have enough controls in place to make sure U.S. manufacturers are properly claiming the Domestic Production Activities Deduction on their tax returns, according to a new report.
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The tax deduction dates back to a 2004 law known as the American Jobs Creation Act. The legislation aimed to improve the ability of domestic manufacturing companies to compete globally and create more small business jobs in the U.S. The law enabled businesses to claim the Domestic Production Activities Deduction on their tax returns. From 2013 through 2015, companies claimed more than $131 billion in DPADs, with nearly $44 billion claimed in 2015 alone.
The report found, however, the IRS has not set up processes to ensure that small businesses filing as individual taxpayers are eligible to claim the DPAD. TIGTA identified 177 electronically filed Form 1040 returns for 2013 that claimed $850,329 in the DPAD without the proper supporting information. The report made four recommendations for the IRS to improve its controls for identifying potentially erroneous DPAD claims, and the IRS agreed with two of the suggestions.
IRS management explained that systemically identifying businesses and corporations overclaiming the deduction presents a challenge because many corporations file returns as part of a consolidated group, receive the DPAD from a pass-through entity, or use a Professional Employer Organization.
The IRS also pointed to the budget constraints it faces, making it difficult to perform the time-consuming audits. “DPAD is a complex issue and in most cases requires an audit to determine whether the activities qualify for the deduction and to calculate the domestic production gross receipts (DPGR) and expenses properly allocable to DPGR in addition to other issues,” wrote Douglas W. O’Donnell, commissioner of the IRS’s Large Business & International division, in response to the report. “These challenges are further compound by cuts to the IRS’s budget. Your report includes potential increased revenue and revenue protection of less than $6 million, which is a small fraction of the nearly $43 billion in DPAD claimed in Processing Year 2013. Given constraints on resources, we have to make strategic and risk-based decisions to ensure our limited resources are allocated to areas with the highest levels of potential noncompliance.”
