(a) In general. The provisions of this section apply solely for purposes of section 199 of the Internal Revenue Code (Code).

(b) Partnerships—(1) In general—(i) Determination at partner level. The deduction with respect to the qualified production activities of the partnership allowable under §1.199-1(a) (section 199 deduction) is determined at the partner level. As a result, each partner must compute its deduction separately. The section 199 deduction has no effect on the adjusted basis of the partner's interest in the partnership. Except as provided by publication pursuant to paragraph (b)(1)(ii) of this section, for purposes of this section, each partner is allocated, in accordance with sections 702 and 704, its share of partnership items (including items of income, gain, loss, and deduction), cost of goods sold (CGS) allocated to such items of income, and gross receipts that are included in such items of income, even if the partner's share of CGS and other deductions and losses exceeds domestic production gross receipts (DPGR) (as defined in §1.199-3(a)) and regardless of the amount of the partner's share of W-2 wages (as defined in §1.199-2(e)) of the partnership for the taxable year. A partnership may specially allocate items of income, gain, loss, or deduction to its partners, subject to the rules of section 704(b) and the supporting regulations. Guaranteed payments under section 707(c) are not considered allocations of partnership income for purposes of this section. Guaranteed payments under section 707(c) are deductions by the partnership that must be taken into account under the rules of §1.199-4. See §1.199-3(p) and paragraph (b)(6) Example 5 of this section. Except as provided in paragraph (b)(1)(ii) of this section, to determine its section 199 deduction for the taxable year, a partner aggregates its distributive share of such items, to the extent they are not otherwise disallowed by the Code, with those items it incurs outside the partnership (whether directly or indirectly) for purposes of allocating and apportioning deductions to DPGR and computing its qualified production activities income (QPAI) (as defined in §1.199-1(c)).

(ii) Determination at entity level. The Secretary may, by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), permit a partnership to calculate a partner's share of QPAI at the entity level, instead of allocating, in accordance with sections 702 and 704, the partner's share of partnership items (including items of income, gain, loss, and deduction). If a partnership does calculate QPAI at the entity level—

(A) The partner is allocated its share of QPAI and W-2 wages (as defined in §1.199-2(e)), which (subject to the limitations of paragraph (b)(2) of this section and section 199(d)(1)(A)(iii), respectively) are combined with the partner's QPAI and W-2 wages from other sources;

(B) For purposes of computing the partner's QPAI under §§1.199-1 through 1.199-9, a partner does not take into account the items from the partnership (for example, a partner does not take into account items from the partnership in determining whether a threshold or de minimis rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(C) A partner generally does not recompute its share of QPAI from the partnership using another method; however, the partner might have to adjust its share of QPAI from the partnership to take into account certain disallowed losses or deductions, or the allowance of suspended losses or deductions; and

(D) A partner's distributive share of QPAI from a partnership may be less than zero.

(2) Disallowed losses or deductions. Except as provided by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), losses or deductions of a partnership that otherwise would be taken into account in computing the partner's section 199 deduction for a taxable year are taken into account in that year only if and to the extent the partner's distributive share of those losses or deductions from all of the partnership's activities is not disallowed by section 465, 469, or 704(d), or any other provision of the Code. If only a portion of the partner's distributive share of the losses or deductions is allowed for a taxable year, a proportionate share of those allowable losses or deductions that are allocated to the partnership's qualified production activities, determined in a manner consistent with sections 465, 469, and 704(d), and any other applicable provision of the Code, is taken into account in computing QPAI and the wage limitation of section 199(d)(1)(A)(iii) for that taxable year. To the extent that any of the disallowed losses or deductions are allowed in a later taxable year, the partner takes into account a proportionate share of those losses or deductions in computing its QPAI for that later taxable year. Losses or deductions of the partnership that are disallowed for taxable years beginning on or before December 31, 2004, are not taken into account in a later taxable year for purposes of computing the partner's QPAI or the wage limitation of section 199(d)(1)(A)(iii) for that taxable year, regardless of whether the losses or deductions are allowed for other purposes.

(3) Partner's share of W-2 wages. Under section 199(d)(1)(A)(iii), a partner's share of W-2 wages of a partnership for purposes of determining the partner's section 199(b) wage limitation is the lesser of the partner's allocable share of those wages (without regard to section 199(d)(1)(A)(iii)), or 2 times 3 percent of the QPAI computed by taking into account only the items of the partnership allocated to the partner for the taxable year of the partnership. Except as provided by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), this QPAI calculation is performed by the partner using the same cost allocation method that the partner uses in calculating the partner's section 199 deduction. The partnership must allocate W-2 wages (prior to the application of the wage limitation) among the partners in the same manner as wage expense. The partner must add the partner's share of the W-2 wages from the partnership, as limited by section 199(d)(1)(A)(iii), to the partner's W-2 wages from other sources, if any. If QPAI, computed by taking into account only the items of the partnership allocated to the partner for the taxable year (as required by the wage limitation of section 199(d)(1)(A)(iii)) is not greater than zero, then the partner may not take into account any W-2 wages of the partnership in applying the wage limitation of §1.199-2 (but the partner will, nevertheless, aggregate its distributive share of partnership items including wage expense with those items not from the partnership in computing its QPAI when determining its section 199 deduction). See §1.199-2 for the computation of W-2 wages, and paragraph (g) of this section for rules regarding pass-thru entities in a tiered structure.

(4) Transition percentage rule for W-2 wages. With regard to partnerships, for purposes of section 199(d)(1)(A)(iii)(II) the transition percentages determined under section 199(a)(2) shall be determined by reference to the partnership's taxable year. Thus, if a partner uses a calendar year taxable year, and owns an interest in a partnership that has a taxable year ending on April 30, the partner's section 199(d)(1)(A)(iii) wage limitation for the partnership's taxable year beginning on May 1, 2006, would be calculated using 3 percent, even though the partner includes the partner's distributive share of partnership items from that taxable year on the partner's 2007 Federal income tax return.

(5) Partnerships electing out of subchapter K. For purposes of §§1.199-1 through 1.199-9, the rules of this paragraph (b) apply to all partnerships, including those partnerships electing under section 761(a) to be excluded, in whole or in part, from the application of subchapter K of chapter 1 of the Code.

(6) Examples. The following examples illustrate the application of this paragraph (b). Assume that each partner has sufficient adjusted gross income or taxable income so that the section 199 deduction is not limited under section 199(a)(1)(B); that the partnership and each of its partners (whether individual or corporate) are calendar year taxpayers; and that the amount of the partnership's W-2 wages equals wage expense for each taxable year. The examples are as follows:

(c) S corporations—(1) In general—(i) Determination at shareholder level. The section 199 deduction with respect to the qualified production activities of an S corporation is determined at the shareholder level. As a result, each shareholder must compute its deduction separately. The section 199 deduction will have no effect on the basis of a shareholder's stock in an S corporation. Except as provided by publication pursuant to paragraph (c)(1)(ii) of this section, for purposes of this section, each shareholder is allocated, in accordance with section 1366, its pro rata share of S corporation items (including items of income, gain, loss, and deduction), CGS allocated to such items of income, and gross receipts included in such items of income, even if the shareholder's share of CGS and other deductions and losses exceeds DPGR, and regardless of the amount of the shareholder's share of the W-2 wages of the S corporation for the taxable year. Except as provided by publication under paragraph (c)(1)(ii) of this section, to determine its section 199 deduction for the taxable year, the shareholder aggregates its pro rata share of such items, to the extent they are not otherwise disallowed by the Code, with those items it incurs outside the S corporation (whether directly or indirectly) for purposes of allocating and apportioning deductions to DPGR and computing its QPAI.

(ii) Determination at entity level. The Secretary may, by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), permit an S corporation to calculate a shareholder's share of QPAI at the entity level, instead of allocating, in accordance with section 1366, the shareholder's pro rata share of S corporation items (including items of income, gain, loss, and deduction). If an S corporation does calculate QPAI at the entity level—

(A) Each shareholder is allocated its share of QPAI and W-2 wages, which (subject to the limitations under paragraph (c)(2) of this section and section 199(d)(1)(A)(iii), respectively) are combined with the shareholder's QPAI and W-2 wages from other sources;

(B) For purposes of computing the shareholder's QPAI under §§1.199-1 through 1.199-9, a shareholder does not take into account the items from the S corporation (for example, a shareholder does not take into account items from the S corporation in determining whether a threshold or de minimis rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(C) A shareholder generally does not recompute its share of QPAI from the S corporation using another method; however, the shareholder might have to adjust its share of QPAI from the S corporation to take into account certain disallowed losses or deductions, or the allowance of suspended losses or deductions; and

(D) A shareholder's share of QPAI from an S corporation may be less than zero.

(2) Disallowed losses or deductions. Except as provided by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), losses or deductions of the S corporation that otherwise would be taken into account in computing the shareholder's section 199 deduction for a taxable year are taken into account in that year only if and to the extent the shareholder's pro rata share of the losses or deductions from all of the S corporation's activities is not disallowed by section 465, 469, or 1366(d), or any other provision of the Code. If only a portion of the shareholder's share of the losses or deductions is allowed for a taxable year, a proportionate share of those allowable losses or deductions that are allocated to the S corporation's qualified production activities, determined in a manner consistent with sections 465, 469, and 1366(d), and any other applicable provision of the Code, is taken into account in computing the QPAI and the wage limitation of section 199(d)(1)(A)(iii) for that taxable year. To the extent that any of the disallowed losses or deductions are allowed in a later taxable year, the shareholder takes into account a proportionate share of those losses or deductions in computing its QPAI for that later taxable year. Losses or deductions of the S corporation that are disallowed for taxable years beginning on or before December 31, 2004, are not taken into account in a later taxable year for purposes of computing the shareholder's QPAI or the wage limitation of section 199(d)(1)(A)(iii) for that taxable year, regardless of whether the losses or deductions are allowed for other purposes.

(3) Shareholder's share of W-2 wages. Under section 199(d)(1)(A)(iii), an S corporation shareholder's share of the W-2 wages of the S corporation for purposes of determining the shareholder's section 199(b) limitation is the lesser of the shareholder's allocable share of those wages (without regard to section 199(d)(1)(A)(iii)), or 2 times 3 percent of the QPAI computed by taking into account only the items of the S corporation allocated to the shareholder for the taxable year of the S corporation. Except as provided by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), this QPAI calculation is performed by the shareholder using the same cost allocation method that the shareholder uses in calculating the shareholder's section 199 deduction. The S corporation must allocate W-2 wages (prior to the application of the wage limitation) among the shareholders in the same manner as wage expense. The shareholder must add the shareholder's share of W-2 wages from the S corporation, as limited by section 199(d)(1)(A)(iii), to the shareholder's W-2 wages from other sources, if any. If QPAI, computed by taking into account only the items of the S corporation allocated to the shareholder for the taxable year (as required by the wage limitation of section 199(d)(1)(A)(iii)), is not greater than zero, then the shareholder may not take into account any W-2 wages of the S corporation in applying the wage limitation of §1.199-2 (but the shareholder will, nevertheless, aggregate its distributive share of S corporation items including wage expense with those items not from the S corporation in computing its QPAI when determining its section 199 deduction). See §1.199-2 for the computation of W-2 wages, and paragraph (g) of this section for rules regarding pass-thru entities in a tiered structure.

(4) Transition percentage rule for W-2 wages. With regard to S corporations, for purposes of section 199(d)(1)(A)(iii)(II) the transition percentages determined under section 199(a)(2) shall be determined by reference to the S corporation's taxable year. Thus, if an S corporation shareholder uses a calendar year taxable year, and owns stock in an S corporation that has a taxable year ending on April 30, the shareholder's section 199(d)(1)(A)(iii) wage limitation for the S corporation's taxable year beginning on May 1, 2006, would be calculated using 3 percent, even though the shareholder includes the shareholder's pro rata share of S corporation items from that taxable year on the shareholder's 2007 Federal income tax return.

(d) Grantor trusts. To the extent that the grantor or another person is treated as owning all or part (the owned portion) of a trust under sections 671 through 679, such person (owner) computes its QPAI with respect to the owned portion of the trust as if that QPAI had been generated by activities performed directly by the owner. Similarly, for purposes of the section 199(b) wage limitation, the owner of the trust takes into account the owner's share of the W-2 wages of the trust that are attributable to the owned portion of the trust. The section 199(d)(1)(A)(iii) wage limitation is not applicable to the owned portion of the trust. The provisions of paragraph (e) of this section do not apply to the owned portion of a trust.

(e) Non-grantor trusts and estates—(1) Allocation of costs. The trust or estate calculates each beneficiary's share (as well as the trust's or estate's own share, if any) of QPAI and W-2 wages from the trust or estate at the trust or estate level. The beneficiary of a trust or estate is not permitted to use another cost allocation method to recompute its share of QPAI from the trust or estate or to reallocate the costs of the trust or estate. Except as provided in paragraph (d) of this section, the QPAI of a trust or estate must be computed by allocating expenses described in section 199(d)(5) in one of two ways, depending on the classification of those expenses under §1.652(b)-3. Specifically, directly attributable expenses within the meaning of §1.652(b)-3 are allocated pursuant to §1.652(b)-3, and expenses not directly attributable within the meaning of §1.652(b)-3 (other expenses) are allocated under the simplified deduction method of §1.199-4(e) (unless the trust or estate does not qualify to use the simplified deduction method, in which case it must use the section 861 method of §1.199-4(d) with respect to such other expenses). For this purpose, depletion and depreciation deductions described in section 642(e) and amortization deductions described in section 642(f) are treated as other expenses described in section 199(d)(5). Also for this purpose, the trust's or estate's share of other expenses from a lower-tier pass-thru entity is not directly attributable to any class of income (whether or not those other expenses are directly attributable to the aggregate pass-thru gross income as a class for purposes other than section 199). A trust or estate may not use the small business simplified overall method for computing its QPAI. See §1.199-4(f)(5).

(2) Allocation among trust or estate and beneficiaries—(i) In general. The QPAI of a trust or estate (which will be less than zero if the CGS and deductions allocated and apportioned to DPGR exceed the trust's or estate's DPGR) and W-2 wages of a trust or estate are allocated to each beneficiary and to the trust or estate based on the relative proportion of the trust's or estate's distributable net income (DNI), as defined by section 643(a), for the taxable year that is distributed or required to be distributed to the beneficiary or is retained by the trust or estate. For this purpose, the trust or estate's DNI is determined with regard to the separate share rule of section 663(c), but without regard to section 199. To the extent that the trust or estate has no DNI for the taxable year, any QPAI and W-2 wages are allocated entirely to the trust or estate. A trust or estate is allowed the section 199 deduction in computing its taxable income to the extent that QPAI and W-2 wages are allocated to the trust or estate. A beneficiary of a trust or estate is allowed the section 199 deduction in computing its taxable income based on its share of QPAI and W-2 wages from the trust or estate, which (subject to the wage limitation as described in paragraph (e)(3) of this section) are aggregated with the beneficiary's QPAI and W-2 wages from other sources, if any.

(ii) Treatment of items from a trust or estate reporting qualified production activities income. When, pursuant to this paragraph (e), a taxpayer must combine QPAI and W-2 wages from a trust or estate with the taxpayer's total QPAI and W-2 wages from other sources, the taxpayer, when applying §§1.199-1 through 1.199-9 to determine the taxpayer's total QPAI and W-2 wages from such other sources, does not take into account the items from such trust or estate. Thus, for example, a beneficiary of an estate that receives QPAI from the estate does not take into account the beneficiary's distributive share of the estate's gross receipts, gross income, or deductions when the beneficiary determines whether a threshold or de minimis rule applies or when the beneficiary allocates and apportions deductions in calculating its QPAI from other sources.

(3) Beneficiary's share of W-2 wages. The trust or estate must compute each beneficiary's share of W-2 wages from the trust or estate in accordance with section 199(d)(1)(A)(iii), as if the beneficiary were a partner in a partnership. The application of section 199(d)(1)(A)(iii) to each trust and estate therefore means that if QPAI, computed by taking into account only the items of the trust or estate allocated to the beneficiary for the taxable year, is not greater than zero, then the beneficiary may not take into account any W-2 wages of the trust or estate in applying the wage limitation of §1.199-2 (but the beneficiary will, nevertheless, aggregate its QPAI from the trust or estate with its QPAI from other sources when determining the beneficiary's section 199 deduction). See paragraph (g) of this section for rules applicable to pass-thru entities in a tiered structure.

(4) Transition percentage rule for W-2 wages. With regard to trusts and estates, for purposes of section 199(d)(1)(A)(iii)(II), the transition percentages determined under section 199(a)(2) shall be determined by reference to the taxable year of the trust or estate.

(5) Example. The following example illustrates the application of this paragraph (e) and paragraph (g) of this section. Assume that the partnership, trust, and trust beneficiary all are calendar year taxpayers.

(f) Gain or loss from the disposition of an interest in a pass-thru entity. DPGR generally does not include gain or loss recognized on the sale, exchange, or other disposition of an interest in a pass-thru entity. However, with respect to a partnership, if section 751(a) or (b) applies, then gain or loss attributable to assets of the partnership giving rise to ordinary income under section 751(a) or (b), the sale, exchange, or other disposition of which would give rise to DPGR, is taken into account in computing the partner's section 199 deduction. Accordingly, to the extent that cash or property received by a partner in a sale or exchange for all or part of its partnership interest is attributable to unrealized receivables or inventory items within the meaning of section 751(c) or (d), respectively, and the sale or exchange of the unrealized receivable or inventory items would give rise to DPGR if sold, exchanged, or otherwise disposed of by the partnership, the cash or property received by the partner is taken into account by the partner in determining its DPGR for the taxable year. Likewise, to the extent that a distribution of property to a partner is treated under section 751(b) as a sale or exchange of property between the partnership and the distributee partner, and any property deemed sold or exchanged would give rise to DPGR if sold, exchanged, or otherwise disposed of by the partnership, the deemed sale or exchange of the property must be taken into account in determining the partnership's and distributee partner's DPGR to the extent not taken into account under the qualifying in-kind partnership rules. See §1.751-1(b) and paragraph (i) of this section.

(g) Section 199(d)(1)(A)(iii) wage limitation and tiered structures—(1) In general. If a pass-thru entity owns an interest, directly or indirectly, in one or more pass-thru entities, then the wage limitation of section 199(d)(1)(A)(iii) must be applied at each tier (that is, separately for each entity). For purposes of this wage limitation, references to pass-thru entities includes partnerships, S corporations, trusts (to the extent not described in paragraph (d) of this section) and estates. Thus, at each tier, the owner of a pass-thru entity (or the entity on behalf of the owner) calculates the amounts described in sections 199(d)(1)(A)(iii)(I) (owner's allocable share) and 199(d)(1)(A)(iii)(II) (twice the applicable percentage of the owner's QPAI from that entity) separately with regard to its interest in that pass-thru entity.

(2) Share of W-2 wages. For purposes of section 199(d)(1)(A)(iii) and section 199(b), the W-2 wages of the owner of an interest in a pass-thru entity (upper-tier entity) that owns an interest in one or more pass-thru entities (lower-tier entities) are equal to the sum of the owner's allocable share of W-2 wages of the upper-tier entity, as limited in accordance with section 199(d)(1)(A)(iii), and the owner's own W-2 wages. The upper-tier entity's W-2 wages are equal to the sum of the upper-tier entity's allocable share of W-2 wages of the next lower-tier entity, as limited in accordance with section 199(d)(1)(A)(iii), and the upper-tier entity's own W-2 wages. The W-2 wages of each lower-tier entity in a tiered structure, in turn, is computed as described in the preceding sentence. Except as provided by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter)—

(i) An upper-tier entity may compute its share of QPAI attributable to items from a lower-tier entity solely for purposes of section 199(d)(1)(A)(iii)(II) by applying either the section 861 method described in §1.199-4(d) or the simplified deduction method described in §1.199-4(e), provided the upper tier entity would otherwise qualify to use such method.

(ii) Alternatively, the upper-tier entity (other than a trust or estate described in paragraph (e) of this section) may compute its share of QPAI attributable to items from a lower-tier entity solely for purposes of section 199(d)(1)(A)(iii)(II) by applying the small business simplified overall method described in §1.199-4(f), regardless of whether such upper-tier entity would otherwise qualify to use the small business simplified overall method.

(3) Example. The following example illustrates the application of this paragraph (g). Assume that each partnership and each partner (whether or not an individual) is a calendar year taxpayer.

(h) No attribution of qualified activities. Except as provided in paragraph (i) of this section regarding qualifying in-kind partnerships and paragraph (j) of this section regarding EAG partnerships, an owner of a pass-thru entity is not treated as conducting the qualified production activities of the pass-thru entity, and vice versa. This rule applies to all partnerships, including partnerships that have elected out of subchapter K under section 761(a). Accordingly, if a partnership MPGE QPP within the United States, or produces a qualified film or produces utilities in the United States, and distributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partner who then, without performing its own qualifying MPGE or other production, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partner's gross receipts from this latter lease, rental, license, sale, exchange, or other disposition are treated as non-DPGR. In addition, if a partner MPGE QPP within the United States, or produces a qualified film or produces utilities in the United States, and contributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partnership which then, without performing its own qualifying MPGE or other production, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partnership's gross receipts from this latter disposition are treated as non-DPGR.

(i) Qualifying in-kind partnership—(1) In general. If a partnership is a qualifying in-kind partnership described in paragraph (i)(2) of this section, then each partner is treated as MPGE or producing the property MPGE or produced by the partnership that is distributed to that partner. If a partner of a qualifying in-kind partnership derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of the property that was MPGE or produced by the qualifying in-kind partnership, then, provided such partner is a partner of the qualifying in-kind partnership at the time the partner disposes of the property, the partner is treated as conducting the MPGE or production activities previously conducted by the qualifying in-kind partnership with respect to that property. With respect to a lease, rental, or license, the partner is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts derived from the lease, rental, or license under its methods of accounting. With respect to a sale, exchange, or other disposition, the partner is treated as having disposed of the property on the date on which it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account.

(2) Definition of qualifying in-kind partnership. For purposes of this paragraph (i), a qualifying in-kind partnership is a partnership engaged solely in—

(i) The extraction, refining, or processing of oil, natural gas (as described in §1.199-3(l)(2)), petrochemicals, or products derived from oil, natural gas, or petrochemicals in whole or in significant part within the United States;

(ii) The production or generation of electricity in the United States; or

(iii) An activity or industry designated by the Secretary by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter).

(3) Special rules for distributions. If a qualifying in-kind partnership distributes property to a partner, then, solely for purposes of section 199(d)(1)(A)(iii)(II), the partnership is treated as having gross receipts in the taxable year of the distribution equal to the fair market value of the distributed property at the time of distribution to the partner and the deemed gross receipts are allocated to that partner, provided that the partner derives gross receipts from the distributed property (and takes into account such receipts under its method of accounting) during the taxable year of the partner with or within which the partnership's taxable year (in which the distribution occurs) ends. For rules for taking costs into account (such as costs included in the adjusted basis of the distributed property), see §1.199-4.

(4) Other rules. Except as provided in this paragraph (i), a qualifying in-kind partnership is treated the same as other partnerships for purposes of section 199. Accordingly, a qualifying in-kind partnership is subject to the rules of this section regarding the application of section 199 to pass-thru entities, including application of the section 199(d)(1)(A)(iii) wage limitation under paragraph (b)(3) of this section. In determining whether a qualifying in-kind partnership or its partners MPGE QPP in whole or in significant part within the United States, see §1.199-3(g)(2) and (3).

(5) Example. The following example illustrates the application of this paragraph (i). Assume that PRS and X are calendar year taxpayers.

(j) Partnerships owned by members of a single expanded affiliated group—(1) In general. For purposes of this section, if all of the interests in the capital and profits of a partnership are owned by members of a single EAG at all times during the taxable year of the partnership (EAG partnership), then the EAG partnership and all members of that EAG are treated as a single taxpayer for purposes of section 199(c)(4) during that taxable year.

(2) Attribution of activities—(i) In general. If a member of an EAG (disposing member) derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by an EAG partnership, all the partners of which are members of the same EAG to which the disposing member belongs at the time that the disposing member disposes of such property, then the disposing member is treated as conducting the MPGE or production activities previously conducted by the EAG partnership with respect to that property. The previous sentence applies only for those taxable years in which the disposing member is a member of the EAG of which all the partners of the EAG partnership are members for the entire taxable year of the EAG partnership. With respect to a lease, rental, or license, the disposing member is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts from the lease, rental, or license under its methods of accounting. With respect to a sale, exchange, or other disposition, the disposing member is treated as having disposed of the property on the date on which it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account. Likewise, if an EAG partnership derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by a member (or members) of the same EAG (the producing member) to which all the partners of the EAG partnership belong at the time that the EAG partnership disposes of such property, then the EAG partnership is treated as conducting the MPGE or production activities previously conducted by the producing member with respect to that property. The previous sentence applies only for those taxable years in which the producing member is a member of the EAG of which all the partners of the EAG partnership are members for the entire taxable year of the EAG partnership. With respect to a lease, rental, or license, the EAG partnership is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts derived from the lease, rental, or license under its methods of accounting. With respect to a sale, exchange, or other disposition, the EAG partnership is treated as having disposed of the property on the date on which it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account. See paragraph (j)(5) Example 3 of this section.

(ii) Attribution between EAG partnerships. If an EAG partnership (disposing partnership) derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by another EAG partnership (producing partnership), then the disposing partnership is treated as conducting the MPGE or production activities previously conducted by the producing partnership with respect to that property, provided that the producing partnership and the disposing partnership are owned by members of the same EAG for the entire taxable year of the respective partnership in which the disposing partnership disposes of such property. With respect to a lease, rental, or license, the disposing partnership is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts from the lease, rental, or license under its methods of accounting. With respect to a sale, exchange, or other disposition, the disposing partnership is treated as having disposed of the property on the date on which it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account.

(iii) Exceptions to attribution. Attribution of activities does not apply for purposes of the construction of real property under §1.199-3(m)(1) and the performance of engineering and architectural services under §1.199-3(n)(2) and (3), respectively.

(3) Special rules for distributions. If an EAG partnership distributes property to a partner, then, solely for purposes of section 199(d)(1)(A)(iii)(II), the EAG partnership is treated as having gross receipts in the taxable year of the distribution equal to the fair market value of the property at the time of distribution to the partner and the deemed gross receipts are allocated to that partner, provided that the partner derives gross receipts from the distributed property (and takes such receipts into account under its methods of accounting) during the taxable year of the partner with or within which the partnership's taxable year (in which the distribution occurs) ends. For rules for taking costs into account (such as costs included in the adjusted basis of the distributed property), see §1.199-4.

(4) Other rules. Except as provided in this paragraph (j), an EAG partnership is treated the same as other partnerships for purposes of section 199. Accordingly, an EAG partnership is subject to the rules of this section regarding the application of section 199 to pass-thru entities, including application of the section 199(d)(1)(A)(iii) wage limitation under paragraph (b)(3) of this section. In determining whether a member of an EAG or an EAG partnership MPGE QPP in whole or in significant part within the United States or produced a qualified film or produced utilities within the United States, see §1.199-3(g)(2) and (3) and Example 5 of paragraph (j)(5) of this section.

(5) Examples. The following examples illustrate the rules of this paragraph (j). Assume that PRS, X, Y, and Z all are calendar year taxpayers.

(k) Effective dates. Section 199 applies to taxable years beginning after December 31, 2004. In determining the deduction under section 199, items arising from a taxable year of a partnership, S corporation, estate, or trust beginning before January 1, 2005, shall not be taken into account for purposes of section 199(d)(1). Section 1.199-9 does not apply to taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005 (Public Law 109-222, 120 Stat. 345). For taxable years beginning on or before May 17, 2006, a taxpayer must apply §1.199-9 if the taxpayer applies §§1.199-1 through 1.199-8 to that taxable year. Notwithstanding the preceding sentence, a partnership or S corporation that is a qualifying small taxpayer under §1.199-4(f) of REG-105847-05 (2005-47 I.R.B. 987) (see §601.601(d)(2) of this chapter) may use the small business simplified overall method to apportion CGS and deductions between DPGR and non-DPGR at the entity level under §1.199-4(f) of REG-105847-05 for taxable years beginning on or before May 17, 2006. If a taxpayer chooses not to rely on §§1.199-1 through 1.199-9 (as provided in §1.199-8(i)) for a taxable year beginning before June 1, 2006, the guidance under section 199 that applies to taxable years beginning before June 1, 2006, is contained in Notice 2005-14 (2005-1 C.B. 498) (see §601.601(d)(2) of this chapter). In addition, a taxpayer also may rely on the provisions of REG-105847-05 for taxable years beginning before June 1, 2006. If Notice 2005-14 and REG-105847-05 include different rules for the same particular issue, then a taxpayer may rely on either the rule set forth in Notice 2005-14 or the rule set forth in REG-105847-05. However, if REG-105847-05 includes a rule that was not included in Notice 2005-14, then a taxpayer is not permitted to rely on the absence of a rule in Notice 2005-14 to apply a rule contrary to REG-105847-05. For taxable years beginning after May 17, 2006, and before June 1, 2006, a taxpayer may not apply Notice 2005-14, REG-105847-05, or any other guidance under section 199 in a manner inconsistent with amendments made to section 199 by section 514 of the Tax Increase Prevention and Reconciliation Act of 2005.

[T.D. 9263, 71 FR 31283, June 1, 2006; 72 FR 6, Jan. 3, 2007, as amended by T.D. 9381, 73 FR 8814, Feb. 15, 2008]