Tax Court Denies DPAD After Analyzing Benefits And Burdens

The Tax Court has ruled in ADVO, Inc. v. Commissioner (141 T.C. No. 9) that the domestic production activities deduction (DPAD) under Section 199 was not available for a taxpayer who did not have the benefits and burdens of ownership over the direct advertising materials.

The taxpayer distributed direct mail advertising materials two ways: The taxpayer's clients could supply the advertising materials for the taxpayer to distribute or the taxpayer could supply the materials for distribution. When the taxpayer supplied the advertising materials, the taxpayer contracted with third-party commercial printers to print the materials. The taxpayer provided the third party with the design for the advertising. The Section 199 deductions at issue were attributable to direct mail advertising involving only the taxpayer-supplied materials.

In general, Section 199 allows a taxpayer to deduct a percentage (3% for the year at issue) of income from qualified production activities. The regulations under Section 199 provide that when a taxpayer contracts with an unrelated third party for the manufacturing of its products, the taxpayer must have the benefits and burdens of ownership of the qualified production property to claim the deduction.

The taxpayer contended that its gross receipts from printing direct mail advertising qualified as domestic production gross receipts, but the IRS argued that because the taxpayer contracted its actual printing to third parties, it did not actually manufacture any qualified production property.

The Tax Court determined that the taxpayer did not have the benefits and burdens of ownership during production because of the...