Domestic Production Activity Deduction

The Domestic Production Activity deduction (DPAD) allows business owners with employees who are engaged in the production of tangible personal property and computer software, or provide engineering, architecture and certain construction services, amongst other things, to deduct up to 9% of their qualifying production activities income (QPAI). The DPAD was introduced to provide tax incentives to U.S. manufacturers, however, many small business owners may also be able to realize benefits from the deduction. You can calculate your DPAD using Form 8903, before deducting it from your gross income on your Form 1040. Note that this is not a Schedule C deduction.


Steve is a sole proprietor software developer based in Seattle, Washington who created and now manufactures his own brand of computer operating system. Steve has one employee and manufactures all of his operating systems in Seattle. Since Steve is engaged in a qualifying activity, he would be eligible to take the DPAD. Last year, Steve had income from qualifying production activities (QPAI) of $56,000, his adjusted gross income (AGI) was $80,000 and he paid his employee $40,000. Using Form 8903, Steve determined his DPAD would be equal to 9% of his QPAI, or $5,040 ($56,000 x 9%), since it is less than 9% of his AGI and 50% of W-2 wages paid to his employee), which would be deductible on line 35 of his Form 1040.


Ruby lives in San Diego, California and has a business building custom bicycles out of her garage. Last year, Ruby had one employee who she paid $20,000. Her AGI was $65,000 and her income from qualifying production activities (QPAI) was $70,000. Since building and selling bicycles could be considered qualifying production of tangible personal property, she would be eligible to take the DPAD. Using Form 8903, Ruby determined her DPAD would be equal to 9% of her AGI, or $5,850 ($65,000 x 9%), since it is less than 9% of her QPAI and 50% of W-2 wages paid to her employee.


Lewis is a tasker based in Kansas City, Missouri who splits his time between courier and carpentry activities. Lewis has one employee. His carpentry work would be considered a qualifying production activity. In order to calculate his DPAG, Lewis first needs to determine what his qualifying production activities income (QPAI) is. Last year, Lewis's business had $90,000 of gross receipts ($53,000 of which can be attributed to his carpentry activities) and $35,000 of total expenses (including cost of goods sold). Using the Small Business Simplified Overall Method, Lewis's QPAI would be equal to $32,388 ($53,000 qualifying gross receipts - (($53,000 qualifying activity revenue / $90,000 total revenue) X $35,000 total expenses)), which he would then compare against his AGI and W-2 wages paid to determine his DPAD.


Dan is a full time uber driver who heard of the DPAD through a friend who owns a software development business. Dan asked his accountant if he could take advantage of the DPAD since he does all of his uber driving in the United States. Unfortunately, Dan's accountant informed him that since his ride share business does not fall within the definition of a qualifying domestic production activity, he would not be able to claim the deduction on his Form 1040.


  • DPAD qualifying activities generally include the following if performed in the United States: Construction of real property (including engineering and architectural services), any lease, rental, license, sale, exchange or other disposition of tangible personal property, computer software, and certain film and sound recordings produced by you. The deduction also can apply to activities related to the production of oil and utilities, however, these topics are less relevant for Entrepreneurs. Refer to the IRS for additional details.
  • Your DPAD is generally 9% of the smaller of your qualified production activities income (QPAI) or your adjusted gross income (excluding DPAD). You can calculate your QPAI by subtracting business expenses related to your qualifying activities from your qualifying gross receipts (DPGR). Note that your DPAD cannot exceed 50% of wages paid to your W-2 employees. If you did not pay any W-2 wages you are not allowed to take the DPAD.
  • To calculate your qualifying production activities income (QPAI), you need to know which business expenses relate directly to your qualifying activities (domestic production gross receipts (DPGR)). Since tracking individual expenses can be difficult, if you have under $5 million in gross receipts the IRS allows you to allocate your expenses (including cost of goods sold) between your qualifying gross receipts (DPGR) and non qualifying gross receipts, based on their proportion to your total gross revenue. This allocation method is called the Small Business Simplified Overall Method. The IRS also allows you to use the Simplified Deduction Method and the Section 861 method, however, these are more complicated methods so you should refer to the IRS for additional information.
  • You cannot apply the deduction to income generated from the sale of food or beverages, property you leased or rented to a related person, or to income generated from the lease, license, sale, rental, or exchange of land. Additionally, most income generated from personal services will not qualify for the deduction.
  • The Domestic Production Activity Deduction is a complex topic. There are many detailed rules outlined that we have not included on this page. Different guidance may apply to you depending on your specific business, what activities you are engaged in and how you are organized. You should consult with your tax advisor to determine how this deduction could apply to you specifically.

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