(a) Rules of application—(1) In general. The provisions of this section apply solely for purposes of section 199 of the Internal Revenue Code. The amount of the deduction allowable under §1.199-1(a) (section 199 deduction) to a taxpayer for any taxable year shall not exceed 50 percent of the W-2 wages (as defined in paragraph (e) of this section) of the taxpayer. For this purpose, except as provided in paragraph (a)(3) of this section and paragraph (b) of this section, the Forms W-2, “Wage and Tax Statement,” used in determining the amount of W-2 wages are those issued for the calendar year ending during the taxpayer's taxable year for wages paid to employees (or former employees) of the taxpayer for employment by the taxpayer. For purposes of this section, employees of the taxpayer are limited to employees of the taxpayer as defined in section 3121(d)(1) and (2) (that is, officers of a corporate taxpayer and employees of the taxpayer under the common law rules). See paragraph (a)(3) of this section for the requirement that W-2 wages must have been included in a return filed with the Social Security Administration (SSA) within 60 days after the due date (including extensions) of the return.
(2) Wages paid by entity other than common law employer. In determining W-2 wages, a taxpayer may take into account any wages paid by another entity and reported by the other entity on Forms W-2 with the other entity as the employer listed in Box c of the Forms W-2, provided that the wages were paid to employees of the taxpayer for employment by the taxpayer. If the taxpayer is treated as an employer described in section 3401(d)(1) because of control of the payment of wages (that is, the taxpayer is not the common law employer of the payee of the wages), the payment of wages may not be included in determining W-2 wages of the taxpayer. If the taxpayer is paying wages as an agent of another entity to individuals who are not employees of the taxpayer, the wages may not be included in determining the W-2 wages of the taxpayer.
(3) Requirement that wages must be reported on return filed with the Social Security Administration—(i) In general. The term W-2 wages shall not include any amount that is not properly included in a return filed with SSA on or before the 60th day after the due date (including extensions) for such return. Under §31.6051-2 of this chapter, each Form W-2 and the transmittal Form W-3, “Transmittal of Wage and Tax Statements,” together constitute an information return to be filed with SSA. Similarly, each Form W-2c, “Corrected Wage and Tax Statement,” and the transmittal Form W-3 or W-3c, “Transmittal of Corrected Wage and Tax Statements,” together constitute an information return to be filed with SSA. In determining whether any amount has been properly included in a return filed with SSA on or before the 60th day after the due date (including extensions) for such return, each Form W-2 together with its accompanying Form W-3 shall be considered a separate information return and each Form W-2c together with its accompanying Form W-3 or Form W-3c shall be considered a separate information return. Section 31.6071(a)-1(a)(3) of this chapter provides that each information return in respect of wages as defined in the Federal Insurance Contributions Act or of income tax withheld from wages which is required to be made under §31.6051-2 of this chapter shall be filed on or before the last day of February (March 31 if filed electronically) of the year following the calendar year for which it is made, except that if a tax return under §31.6011(a)-5(a) of this chapter is filed as a final return for a period ending prior to December 31, the information statement shall be filed on or before the last day of the second calendar month following the period for which the tax return is filed. Corrected Forms W-2 are required to be filed with SSA on or before the last day of February (March 31 if filed electronically) of the year following the year in which the correction is made, except that if a tax return under §31.6011(a)-5(a) is filed as a final return for a period ending prior to December 31 for the period in which the correction is made, the corrected Forms W-2 are required to be filed by the last day of the second calendar month following the period for which the final return is filed.
(ii) Corrected return filed to correct a return that was filed within 60 days of the due date. If a corrected information return (Return B) is filed with SSA on or before the 60th day after the due date (including extensions) of Return B to correct an information return (Return A) that was filed with SSA on or before the 60th day after the due date (including extensions) of the information return (Return A) and paragraph (a)(3)(iii) of this section does not apply, then the wage information on Return B must be included in determining W-2 wages. If a corrected information return (Return D) is filed with SSA later than the 60th day after the due date (including extensions) of Return D to correct an information return (Return C) that was filed with SSA on or before the 60th day after the due date (including extensions) of the information return (Return C), then if Return D reports an increase (or increases) in wages included in determining W-2 wages from the wage amounts reported on Return C, then such increase (or increases) on Return D shall be disregarded in determining W-2 wages (and only the wage amounts on Return C may be included in determining W-2 wages). If Return D reports a decrease (or decreases) in wages included in determining W-2 wages from the amounts reported on Return C, then, in determining W-2 wages, the wages reported on Return C must be reduced by the decrease (or decreases) reflected on Return D.
(iii) Corrected return filed to correct a return that was filed later than 60 days after the due date. If an information return (Return F) is filed to correct an information return (Return E) that was not filed with SSA on or before the 60th day after the due date (including extensions) of Return E, then Return F (and any subsequent information returns filed with respect to Return E) will not be considered filed on or before the 60th day after the due date (including extensions) of Return F (or the subsequent corrected information return). Thus, if a Form W-2c (or corrected Form W-2) is filed to correct a Form W-2 that was not filed with SSA on or before the 60th day after the due date (including extensions) of the information return including the Form W-2 (or to correct a Form W-2c relating to an information return including a Form W-2 that had not been filed with SSA on or before the 60th day after the due date (including extensions) of the information return including the Form W-2), then the information return including this Form W-2c (or corrected Form W-2) shall not be considered to have been filed with SSA on or before the 60th day after the due date (including extensions) for this information return including the Form W-2c (or corrected Form W-2), regardless of when the information return including the Form W-2c (or corrected Form W-2) is filed.
(4) Joint return. An individual and his or her spouse are considered one taxpayer for purposes of determining the amount of W-2 wages for a taxable year, provided that they file a joint return for the taxable year. Thus, an individual filing as part of a joint return may include the wages of employees of his or her spouse in determining W-2 wages, provided the employees are employed in a trade or business of the spouse and the other requirements of this section are met. However, a married taxpayer filing a separate return from his or her spouse for the taxable year may not include the wages of employees of the taxpayer's spouse in determining the taxpayer's W-2 wages for the taxable year.
(b) Application in the case of a taxpayer with a short taxable year. In the case of a taxpayer with a short taxable year, subject to the rules of paragraph (a) of this section, the W-2 wages of the taxpayer for the short taxable year shall include only those wages paid during the short taxable year to employees of the taxpayer, only those elective deferrals (within the meaning of section 402(g)(3)) made during the short taxable year by employees of the taxpayer and only compensation actually deferred under section 457 during the short taxable year with respect to employees of the taxpayer. The Secretary shall have the authority to issue published guidance setting forth the method that is used to calculate W-2 wages in case of a taxpayer with a short taxable year. See paragraph (e)(3) of this section.
(c) [Reserved]. For further guidance see §1.199-2T(c).
(d) Non-duplication rule. Amounts that are treated as W-2 wages for a taxable year under any method shall not be treated as W-2 wages of any other taxable year. Also, an amount shall not be treated as W-2 wages by more than one taxpayer.
(e) Definition of W-2 wages—(1) In general. Under section 199(b)(2), the term W-2 wages means, with respect to any person for any taxable year of such person, the sum of the amounts described in section 6051(a)(3) and (8) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year. Thus, the term W-2 wages includes the total amount of wages as defined in section 3401(a); the total amount of elective deferrals (within the meaning of section 402(g)(3)); the compensation deferred under section 457; and for taxable years beginning after December 31, 2005, the amount of designated Roth contributions (as defined in section 402A).
(2) Limitation on W-2 wages for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005—(i) In general. The term W-2 wages includes only amounts described in paragraph (e)(1) of this section (paragraph (e)(1) wages) that are properly allocable to domestic production gross receipts (DPGR) (as defined in §1.199-3) for purposes of section 199(c)(1). A taxpayer may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances.
(ii) Wage expense safe harbor—(A) In general. A taxpayer using either the section 861 method of cost allocation under §1.199-4(d) or the simplified deduction method under §1.199-4(e) may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR for a taxable year by multiplying the amount of paragraph (e)(1) wages for the taxable year by the ratio of the taxpayer's wage expense included in calculating qualified production activities income (QPAI) (as defined in §1.199-1(c)) for the taxable year to the taxpayer's total wage expense used in calculating the taxpayer's taxable income (or adjusted gross income, if applicable) for the taxable year, without regard to any wage expense disallowed by section 465, 469, 704(d), or 1366(d). A taxpayer that uses the section 861 method of cost allocation under §1.199-4(d) or the simplified deduction method under §1.199-4(e) to determine QPAI must use the same expense allocation and apportionment methods that it uses to determine QPAI to allocate and apportion wage expense for purposes of this safe harbor. For purposes of this paragraph (e)(2)(ii), the term wage expense means wages (that is, compensation paid by the employer in the active conduct of a trade or business to its employees) that are properly taken into account under the taxpayer's method of accounting.
(B) Wage expense included in cost of goods sold. For purposes of paragraph (e)(2)(ii)(A) of this section, a taxpayer may determine its wage expense included in cost of goods sold (CGS) using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances, such as using the amount of direct labor included in CGS or using section 263A labor costs (as defined in §1.263A-1(h)(4)(ii)) included in CGS.
(iii) Small business simplified overall method safe harbor. A taxpayer that uses the small business simplified overall method under §1.199-4(f) may use the small business simplified overall method safe harbor for determining the amount of paragraph (e)(1) wages that is properly allocable to DPGR. Under this safe harbor, the amount of paragraph (e)(1) wages that is properly allocable to DPGR is equal to the same proportion of paragraph (e)(1) wages that the amount of DPGR bears to the taxpayer's total gross receipts.
(iv) Examples. The following examples illustrate the application of this paragraph (e)(2). See §1.199-5(e)(4) for an example of the application of paragraph (e)(2)(ii) of this section to a trust or estate. The examples read as follows:
| DPGR (all from sales of products within SIC AAA) | $3,000 |
| Non-DPGR (all from sales of products within SIC BBB) | 3,000 |
| CGS allocable to DPGR (includes $200 of wage expense) | (600) |
| CGS allocable to non-DPGR (includes $600 of wage expense) | (1,800) |
| Section 162 selling expenses (includes $600 of wage expense) | (840) |
| Section 174 R&E-SIC AAA (includes $100 of wage expense) | (300) |
| Section 174 R&E-SIC BBB (includes $200 of wage expense) | (600) |
| Interest expense (not included in CGS) | (300) |
| Headquarters overhead expense (includes $100 of wage expense) | (180) |
| X's taxable income | 1,380 |
| DPGR (all from sales of products within SIC AAA) | $3,000 |
| CGS allocable to DPGR | (600) |
| Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts)) | (420) |
| Section 174 R&E-SIC AAA | (300) |
| Interest expense (not included in CGS) ($300 × ($40,000 (X's DPGR assets)/$50,000 (X's total assets))) | (240) |
| Headquarters overhead expense ($180 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet)) | (45) |
| X's QPAI | 1,395 |
(A) Step one. X determines that $625 of wage expense were taken into account in determining its QPAI in paragraph (ii) of this Example 1, as shown in the following table:
| CGS wage expense | $200 |
| Section 162 selling expenses wage expense ($600 × ($3,000 DPGR/$6,000 total gross receipts)) | 300 |
| Section 174 R&E-SIC AAA wage expense | 100 |
| Headquarters overhead wage expense ($100 × (2,000 square feet attributable to DPGR activity/8,000 total square feet)) | 25 |
| Total wage expense taken into account | 625 |
Step one wage expense/X's total wage expense for taxable year ending April 30, 2011 × X's paragraph (e)(1) wages
$625/$1,800 × $3,000 = $1,042
(iv) Section 199 deduction determination. X's tentative deduction under §1.199-1(a) (section 199 deduction) is $124 (.09 × (lesser of QPAI of $1,395 or taxable income of $1,380)) subject to the wage limitation under section 199(b)(1) (W-2 wage limitation) of $521 (50% × $1,042). Accordingly, X's section 199 deduction for its taxable year ending April 30, 2011, is $124.
| DPGR (all from sales of products within SIC AAA) | $3,000 |
| Non-DPGR (all from sales of products within SIC BBB) | 3,000 |
| CGS allocated to DPGR (includes $300 of wage expense) | (1,200) |
| CGS allocated to non-DPGR (includes $300 of wage expense) | (1,200) |
| Section 162 selling expenses (includes $300 of wage expense) | (840) |
| Section 174 R&E-SIC AAA (includes $20 of wage expense) | (100) |
| Section 174 R&E-SIC BBB (includes $60 of wage expense) | (200) |
| Interest expense (not included in CGS and not subject to §1.861-10T) | (500) |
| Charitable contributions | (50) |
| Headquarters overhead expense (includes $40 of wage expense) | (200) |
| Y's taxable income | 1,710 |
| DPGR (all from sales of products within SIC AAA) | $3,000 |
| CGS allocated to DPGR | (600) |
| Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts)) | (420) |
| Section 174 R&E-SIC AAA | (300) |
| Interest expense (not included in CGS and not subject to §1.861-10T) ($300 × ($60,000 (tax book value of X's and Y's DPGR assets)/$100,000 (tax book value of X's and Y's total assets))) | (180) |
| Headquarters overhead expense ($180 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet)) | (45) |
| X's QPAI | 1,455 |
| DPGR (all from sales of products within SIC AAA) | $3,000 |
| CGS allocated to DPGR | (1,200) |
| Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts)) | (420) |
| Section 174 R&E-SIC AAA | (100) |
| Interest expense (not included in CGS and not subject to §1.861-10T) ($500 × ($60,000 (tax book value of X's and Y's DPGR assets)/$100,000 (tax book value of X's and Y's total assets))) | (300) |
| Charitable contributions (not included in CGS) ($50 × ($1,800 gross income attributable to DPGR/$3,600 total gross income)) | (25) |
| Headquarters overhead expense ($200 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet)) | (50) |
| Y's QPAI | 905 |
(B) Y's W-2 wages. Y chooses to use the wage expense safe harbor under paragraph (e)(2)(ii) of this section to determine its W-2 wages, as shown in the following steps:
(1) Step one. Y determines that $480 of wage expense were taken into account in determining its QPAI in paragraph (ii)(B) of this Example 2, as shown in the following table:
| CGS wage expense | $300 |
| Section 162 selling expenses wage expense ($300 × ($3,000 DPGR/$6,000 total gross receipts)) | 150 |
| Section 174 R&E-SIC AAA wage expense | 20 |
| Headquarters overhead wage expense ($40 × (2,000 square feet attributable to DPGR activity/8,000 total square feet)) | 10 |
| Total wage expense taken into account | 480 |
Step one wage expense/Y's total wage expense for taxable year ending April 30, 2011 × Y's paragraph (e)(1) wages
$480/$1,020 × $2,000 = $941
(iv) Section 199 deduction determination. The section 199 deduction of the X and Y EAG is determined by aggregating the separately determined taxable income, QPAI, and W-2 wages of X and Y. See §1.199-7(b). Accordingly, the X and Y EAG's tentative section 199 deduction is $212 (.09 × (lesser of combined QPAI of X and Y of $2,360 (X's QPAI of $1,455 plus Y's QPAI of $905) or combined taxable incomes of X and Y of $3,090 (X's taxable income of $1,380 plus Y's taxable income of $1,710)) subject to the combined W-2 wage limitation of X and Y of $992 (50% × ($1,042 (X's W-2 wages) + $941 (Y's W-2 wages)))). Accordingly, the X and Y EAG's section 199 deduction is $212. The $212 is allocated to X and Y in proportion to their QPAI. See §1.199-7(c).
| DPGR | $3,000 |
| Non-DPGR | 3,000 |
| CGS allocable to DPGR (includes $200 of wage expense) | (600) |
| CGS allocable to non-DPGR (includes $600 of wage expense) | (1,800) |
| Expenses, losses, or deductions (deductions) (includes $1,000 of wage expense) | (2,220) |
| Z's taxable income | 1,380 |
| DPGR | $3,000 |
| CGS allocable to DPGR | (600) |
| Deductions apportioned to DPGR ($2,220 × ($3,000 DPGR/$6,000 total gross receipts)) | (1,110) |
| Z's QPAI | 1,290 |
(A) Step one. Z determines that $700 of wage expense were taken into account in determining its QPAI in paragraph (ii) of this Example 3, as shown in the following table:
| Wage expense included in CGS allocable to DPGR | $200 |
| Wage expense included in deductions ($1,000 in wage expense × ($3,000 DPGR/$6,000 total gross receipts)) | 500 |
| Wage expense allocable to DPGR | 700 |
Step one wage expense / Z's total wage expense for taxable year ending April 30, 2011 × Z's paragraph (e)(1) wages
$700 / $1,800 × $3,000 = $1,167
(iv) Section 199 deduction determination. Z's tentative section 199 deduction is $116 (.09 × (lesser of QPAI of $1,290 or taxable income of $1,380)) subject to the W-2 wage limitation of $584 (50% × $1,167). Accordingly, Z's section 199 deduction for its taxable year ending April 30, 2011, is $116.
| DPGR | $3,000 |
| Non-DPGR | 3,000 |
| CGS and deductions | (4,620) |
| Z's taxable income | 1,380 |
| DPGR | $3,000 |
| CGS and deductions apportioned to DPGR ($4,620 × ($3,000 DPGR/$6,000 total gross receipts)) | (2,310) |
| Z's QPAI | 690 |
| $3,000 in paragraph (e)(1) wages × ($3,000 DPGR/$6,000 total gross receipts) | $1,500 |
(ii) B's W-2 wages. In determining its W-2 wages, B utilizes the wage expense safe harbor described in paragraph (e)(2)(ii) of this section. The entire $100,000 paid by B to its employees is included in B's wage expense included in calculating its QPAI and is the only wage expense used in calculating B's taxable income. Thus, under the wage expense safe harbor described in paragraph (e)(2)(ii) of this section, B's W-2 wages are $100,000 ($100,000 (paragraph (e)(1) wages) × ($100,000 (wage expense used in calculating B's QPAI)/$100,000 (wage expense used in calculating B's taxable income))).
(iii) S's W-2 wages. In determining its W-2 wages, S utilizes the wage expense safe harbor described in paragraph (e)(2)(ii) of this section. Because S's $1,000,000 in receipts from B do not qualify as DPGR and are S's only gross receipts, none of the $800,000 paid by S to its employees is included in S's wage expense included in calculating its QPAI. However, the entire $800,000 is included in calculating S's taxable income. Thus, under the wage expense safe harbor described in paragraph (e)(2)(ii)(A) of this section, S's W-2 wages are $0 ($800,000 (paragraph (e)(1) wages) × ($0 (wage expense used in calculating S's QPAI)/$800,000 (wage expense used in calculating S's taxable income))).
(iv) Determination of EAG's section 199 deduction. The section 199 deduction of the S and B EAG is determined by aggregating the separately determined taxable income or loss, QPAI, and W-2 wages of S and B. See §1.199-7(b). B's taxable income and QPAI are each $4,000,000 ($10,000,000 DPGR − $6,000,000 CGS and other deductions). S's taxable income is $200,000 ($1,000,000 gross receipts − $800,000 total deductions). S's QPAI is $0 ($0 DPGR − $0 CGS and other deductions). B's W-2 wages (as calculated in paragraph (ii) of this Example 5) are $100,000 and S's W-2 wages (as calculated in paragraph (iii) of this Example 5) are $0. The EAG's tentative section 199 deduction is $360,000 (.09 × (lesser of combined QPAI of $4,000,000 (B's QPAI of $4,000,000 + S's QPAI of $0) or combined taxable income of $4,200,000 (B's taxable income of $4,000,000 + S's taxable income of $200,000))) subject to the W-2 wage limitation of $50,000 (50% × ($100,000 (B's W-2 wages) + $0 (S's W-2 wages))). Accordingly, the S and B EAG's section 199 deduction for 2010 is $50,000. The $50,000 is allocated to S and B in proportion to their QPAI. See §1.199-7(c). Because S has no QPAI, the entire $50,000 is allocated to B.
(3) Methods for calculating W-2 wages. The Secretary may provide by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter) for methods to be used in calculating W-2 wages, including W-2 wages for short taxable years. For example, see Rev. Proc. 2006-22 (2006-23 I.R.B. 1033). (see §601.601(d)(2) of this chapter).
[T.D. 9263, 71 FR 31283, June 1, 2006, as amended by T.D. 9293, 71 FR 61665, Oct. 19, 2006; T.D. 9263, 72 FR 5, Jan. 3, 2007; T.D. 9381, 73 FR 8801, Feb. 15, 2008; T.D. 9731, 80 FR 51941, Aug. 27, 2015]
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