Dominic F. Massoni - Newsletters

The IRS has released the annual inflation adjustments for 2026 for the income tax rate tables, plus more than 60 other tax provisions. The IRS makes these cost-of-living adjustments (COLAs) each year to reflect inflation.

2026 Income Tax Brackets

For 2026, the highest income tax bracket of 37 percent applies when taxable income hits:

$768,700 for married individuals filing jointly and surviving spouses,
$640,600 for single individuals and heads of households,
$384,350 for married individuals filing separately, and
$16,000 for estates and trusts.

2026 Standard Deduction

The standard deduction for 2026 is:

$32,200 for married individuals filing jointly and surviving spouses,
$24,150 for heads of households, and
$16,100 for single individuals and married individuals filing separately.

The standard deduction for a dependent is limited to the greater of:

$1,350 or
the sum of $450, plus the dependent’s earned income.

Individuals who are blind or at least 65 years old get an additional standard deduction of:

$1,650 for married taxpayers and surviving spouses, or
$2,050 for other taxpayers.

Alternative Minimum Tax (AMT) Exemption for 2026

The AMT exemption for 2026 is:

$140,200 for married individuals filing jointly and surviving spouses,
$90,100 for single individuals and heads of households,
$70,100 for married individuals filing separately, and
$31,400 for estates and trusts.

The exemption amounts phase out in 2026 when AMTI exceeds:

$1,000,000 for married individuals filing jointly and surviving spouses,
$500,000 for single individuals, heads of households, and married individuals filing separately, and
$104,800 for estates and trusts.

Expensing Code Sec. 179 Property in 2026

For tax years beginning in 2026, taxpayers can expense up to $2,560,000 in section 179 property. However, this dollar limit is reduced when the cost of section 179 property placed in service during the year exceeds $4,090,000.

Estate and Gift Tax Adjustments for 2026

The following inflation adjustments apply to federal estate and gift taxes in 2026:

the gift tax exclusion is $19,000 per donee, or $194,000 for gifts to spouses who are not U.S. citizens;
the federal estate tax exclusion is $15,000,000; and
the maximum reduction for real property under the special valuation method is $1,460,000.

2026 Inflation Adjustments for Other Tax Items

The maximum foreign earned income exclusion amount in 2026 is $132,900.

The IRS also provided inflation-adjusted amounts for the:

adoption credit,
earned income credit,
excludable interest on U.S. savings bonds used for education,
various penalties, and
many other provisions.

Effective Date of 2026 Adjustments

These inflation adjustments generally apply to tax years beginning in 2026, so they affect most returns that will be filed in 2027. However, some specified figures apply to transactions or events in calendar year 2026.

Rev. Proc. 2025-32

IR-2025-103

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The IRS has released the 2025-2026 special per diem rates. Taxpayers use the per diem rates to substantiate certain expenses incurred while traveling away from home. These special per diem rates include:

the special transportation industry meal and incidental expenses (M&IE) rates,
the rate for the incidental expenses only deduction,
and the rates and list of high-cost localities for purposes of the high-low substantiation method.

Transportation Industry Special Per Diem Rates

The special M&IE rates for taxpayers in the transportation industry are:

$80 for any locality of travel in the continental United States (CONUS), and
$86 for any locality of travel outside the continental United States (OCONUS).

Incidental Expenses Only Rate

The rate is $5 per day for any CONUS or OCONUS travel for the incidental expenses only deduction.

High-Low Substantiation Method

For purposes of the high-low substantiation method, the 2025-2026 special per diem rates are:

$319 for travel to any high-cost locality, and
$225 for travel to any other locality within CONUS.

The amount treated as paid for meals is:

$86 for travel to any high-cost locality, and
$74 for travel to any other locality within CONUS

Instead of the meal and incidental expenses only substantiation method, taxpayers may use:

$86 for travel to any high-cost locality, and
$74 for travel to any other locality within CONUS.

Taxpayers using the high-low method must comply with Rev. Proc. 2019-48, I.R.B. 2019-51, 1392. That procedure provides the rules for using a per diem rate to substantiate the amount of ordinary and necessary business expenses paid or incurred while traveling away from home.

Notice 2024-68, I.R.B. 2024-41, 729 is superseded.

Notice 2025-54

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The IRS has issued transitional guidance for reporting certain interest payments received on specified passenger vehicle loans made in the course of a trade or business during calendar year 2025. The guidance applies to reporting obligations under new Code Sec. 6050AA, enacted as part of the One Big, Beautiful Bill Act (P.L. 119-21).

Under Code Sec. 163(h)(4), as amended, "qualified passenger vehicle loan interest" is deductible by an individual for tax years beginning in 2025 through 2028. Code Sec. 6050AA requires any person engaged in a trade or business who receives $600 or more in such interest from an individual in a calendar year to file an information return with the IRS and statements to the borrowers. The information return must include the borrower’s identifying information, the amount of interest paid, loan details, and vehicle information.

Recognizing that lenders may need additional time to update their systems and that the Service must design new reporting forms, the Treasury Department and the IRS have granted temporary relief. For calendar year 2025 only, recipients may satisfy their reporting obligations by providing a statement to each borrower by January 31, 2026, indicating the total amount of interest received in calendar year 2025 on a specified passenger vehicle loan. This information may be delivered electronically, through online portals, or via annual or monthly statements.

No penalties under Code Sec. 6721 or 6722 will be imposed for 2025 if recipients comply with this transitional reporting procedure. The notice is effective for interest received during calendar year 2025. The IRS estimates that approximately 35,800 respondents will issue about 8 million responses annually, with an average burden of 0.25 hours per response.

Notice 2025-57

IR 2025-105

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The IRS issued updates to frequently asked questions (FAQs) about Form 1099-K, Payment Card and Third-Party Network Transactions (Code Sec. 6050W). The updates reflect changes made under the One, Big, Beautiful Bill Act (OBBBA), which reinstated the prior reporting threshold for third-party settlement organizations (TPSOs) and provided clarifications on filing requirements, taxpayer responsibilities, and penalty relief provisions. The updates supersede those issued in FS-2024-03. More information is available here.

Form 1099-K Reporting Threshold

Under the OBBB, the reporting threshold for TPSOs has been restored to the pre-ARPA level, requiring a Form 1099-K to be issued only when the gross amount of payments exceeds $20,000 and the number of transactions exceeds 200. The lower $600 threshold established by the American Rescue Plan Act (ARPA) no longer applies. The IRS noted that while the federal threshold has increased, some states may impose lower thresholds, and TPSOs must comply with those state-level reporting requirements.

Taxpayer Guidance

The FAQs explain that a Form 1099-K reports payments received through payment cards (credit, debit, or stored-value cards) or payment apps and online marketplaces used for selling goods or providing services. All income remains taxable unless excluded by law, even if not reported on a Form 1099-K.

If a Form 1099-K is incorrect or issued in error, taxpayers should contact the filer listed on the form to request a correction. If a corrected form cannot be obtained in time, taxpayers may adjust the reporting on Schedule 1 (Form 1040) by offsetting the erroneous amount when filing their return.

New Clarifications and Examples

The updated FAQs include expanded examples to help taxpayers properly determine income and filing obligations:

Sales of personal items – How to determine taxable gain or nondeductible loss on items sold through online platforms?
Crowdfunding proceeds – When contributions are taxable income versus nontaxable gifts.
Backup withholding – How failure to provide a valid taxpayer identification number (TIN) can result in withholding under Code Sec. 3406?
Multiple Forms 1099-K – How to report combined or duplicate forms properly using Schedule 1 (Form 1040)?

Third-Party Filer Responsibilities

The FAQs reaffirm that merchant acquiring entities and TPSOs are responsible for preparing, filing, and furnishing Form 1099-K statements. There is no de minimis exception for payment-card transactions. Entities that submit payment instructions remain subject to penalties under Code Sec. 6721 and 6722 for failing to file or furnish correct information returns. TPSOs are not required to include Merchant Category Codes (MCCs), while merchant acquiring entities must do so where applicable.

Ticket Sales and Executive Order 14254

The updated FAQs also address Executive Order 14254, Combating Unfair Practices in the Live Entertainment Market, issued in March 2025. The IRS clarified that income from ticket sales and resales is includible in gross income and subject to reporting. Payment settlement entities facilitating these sales must issue Form 1099-K when federal thresholds are met, and non-PSE payors may be required to issue Form 1099-MISC or Form 1099-NEC for payments of $2,000 or more made after December 31, 2025.

Reliance and Penalty Relief

Although the FAQs are not published in the Internal Revenue Bulletin (IRB) and cannot be used as legal precedent, the IRS confirmed that taxpayers who reasonably and in good faith rely on them will not be subject to penalties that allow for a reasonable-cause standard, including negligence or accuracy-related penalties, if such reliance results in an underpayment of tax.

FS-2025-8

IR-2025-107

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For 2026, the Social Security wage cap will be $184,500, and Social Security and Supplemental Security Income (SSI) benefits will increase by 2.8 percent. These changes reflect cost-of-living adjustments to account for inflation.

Wage Cap for Social Security Tax

The Federal Insurance Contributions Act (FICA) tax on wages is 7.65 percent each for the employee and the employer. FICA tax has two components:

a 6.2 percent social security tax, also known as old age, survivors, and disability insurance (OASDI); and
a 1.45 percent Medicare tax, also known as hospital insurance (HI).

For self-employed workers, the Self-Employment tax is 15.3 percent, consisting of:

a 12.4 percent OASDI tax; and
a 2.9 percent HI tax.

OASDI tax applies only up to a wage base, which includes most wages and self-employment income up to the annual wage cap.

For 2026, the wage base is $184,500. Thus, OASDI tax applies only to the taxpayer’s first $184,500 in wages or net earnings from self-employment. Taxpayers do not pay any OASDI tax on earnings that exceed $184,500.

There is no wage cap for HI tax.

Maximum Social Security Tax for 2026

For workers who earn $184,500 or more in 2026:

an employee will pay a total of $11,439 in social security tax ($184,500 x 6.2 percent);
the employer will pay the same amount; and
a self-employed worker will pay a total of $22,878 in social security tax ($184,500 x 12.4 percent).

Additional Medicare Tax

Higher-income workers may have to pay an Additional Medicare tax of 0.9 percent. This tax applies to wages and self-employment income that exceed:

$250,000 for married taxpayers who file a joint return;
$125,000 for married taxpayers who file separate returns; and
$200,000 for other taxpayers.

The annual wage cap does not affect the Additional Medicare tax.

Benefit Increase for 2026

Finally, a cost-of-living adjustment (COLA) will increase social security and SSI benefits for 2026 by 2.8 percent. The COLA is intended to ensure that inflation does not erode the purchasing power of these benefits.

Social Security Fact Sheet: 2026 Social Security Changes

SSA Press Release: Social Security Announces 2.8 Percent Benefit Increase for 2026

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The IRS issued frequently asked questions (FAQs) addressing the limitation on Employee Retention Credit (ERC) claims for the third and fourth quarters of 2021 under the One, Big, Beautiful Bill Act (OBBBA). The FAQs clarify when such claims are disallowed and how the IRS will handle related filings.

Limitation on Late Claims

ERC claims filed after January 31, 2024, for the third and fourth quarters of 2021 will not be allowed or refunded after July 4, 2025, under section 70605(d) of the OBBBA.

Previously Refunded Claims

Claims filed after January 31, 2024, that were refunded or credited before July 4, 2025, are not affected by this limitation. Other IRS compliance reviews, however, may still apply.

Withdrawn Claims

An amended return withdrawing a previously claimed ERC after January 31, 2024, is not subject to section 70605(d). The IRS will process such amended returns.

Filing Date

An ERC claim is considered filed on or before January 31, 2024, if the return was postmarked or electronically submitted by that date.

Processing of Other Items

If an ERC claim is disallowed under section 70605(d), the IRS may still process other items on the same return.

Appeals Rights

Taxpayers whose ERC claims are disallowed will receive Letter 105-C (Claim Disallowed) and may appeal to the IRS Independent Office of Appeals if they believe the claim was timely filed.

FS-2025-7

IR-2025-106

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The IRS identified drought-stricken areas where tax relief is available to taxpayers that sold or exchanged livestock because of drought. The relief extends the deadlines for taxpayers to replace the livestock and avoid reporting gain on the sales. These extensions apply until the drought-stricken area has a drought-free year.

When Sales of Livestock are Involuntary Conversions

Sales of livestock due to drought are involuntary conversions of property. Taxpayers can postpone gain on involuntary conversions if they buy qualified replacement property during the replacement period. Qualified replacement property must be similar or related in service or use to the converted property.

Usually, the replacement period ends two years after the tax year in which the involuntary conversion occurs. However, a longer replacement period applies in several situations, such as when sales occur in a drought-stricken area.

Livestock Sold Because of Weather

Taxpayers have four years to replace livestock they sold or exchanged solely because of drought, flood, or other weather condition. Three conditions apply.

First, the livestock cannot be raised for slaughter, held for sporting purposes or be poultry.

Second, the taxpayer must have held the converted livestock for:

draft,
dairy, or
breeding purposes.

Third, the weather condition must make the area eligible for federal assistance.

Persistent Drought

The IRS extends the four-year replacement period when a taxpayer sells or exchanges livestock due to persistent drought. The extension continues until the taxpayer’s region experiences a drought-free year.

The first drought-free year is the first 12-month period that:

ends on August 31 in or after the last year of the four-year replacement period, and
does not include any weekly period of drought.

What Areas are Suffering from Drought

The National Drought Mitigation Center produces weekly Drought Monitor maps that report drought-stricken areas. Taxpayers can view these maps at

https://droughtmonitor.unl.edu/Maps/MapArchive.aspx.

However, the IRS also provided a list of areas where the year ending on August 31, 2025, was not a drought-free year. The replacement period in these areas will continue until the area has a drought-free year.

Notice 2025-52

IR-2025-93

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The IRS and Treasury have issued final regulations setting forth recordkeeping and reporting requirements for the average income test for purposes of the low-income housing credit. The regulations adopt the proposed and temporary regulations issued in 2022 with only minor, non-substantive changes.

Low-Income Housing Credit

An owner of a newly constructed or substantially rehabilitated qualified low-income building in a qualified low-income housing project may be eligible for the low-income housing tax credit (LIHTC) under Code Sec. 42. A project qualifies as a low-income housing project it satisfies certain set-aside tests or alternatively an average income test.

Under the average income test, at least 40 percent (25 percent in New York City) of a qualified group of residential units must be both rent-restricted and occupied by low-income individuals. Also, the average of the imputed income limitations must not exceed 60 percent of the area median gross income (AMGI).

Recording Keeping and Reporting Requirements

The regulations provide procedures for a taxpayer to identify a qualified group of residential units that satisfy the average income test. This includes recording the identification in the taxpayer’s books and records, including a change in a unit’s imputed income limit. The taxpayer also must communicate the annual identification to the applicable housing agency.

The final regulations clarify the submission of a corrected qualified group when the taxpayer or housing agency realizes that a previously submitted group fails to be a qualified group. The housing agency is also allowed the discretion to permit a taxpayer to submit one or two lists qualified groups of low-income units to demonstrate compliance with the minimum set-aside test and the applicable fractions for the building.

(T.D. 10036)

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Starting in 2010, the $100,000 adjusted gross income cap for converting a traditional IRA into a Roth IRA is eliminated. All other rules continue to apply, which means that the amount converted to a Roth IRA still will be taxed as income at the individual's marginal tax rate. One exception for 2010 only: you will have a choice of recognizing the conversion income in 2010 or averaging it over 2011 and 2012.

The Tax Increase Prevention and Reconciliation Act of 2005 eliminated the $100,000 adjusted gross income (AGI) ceiling for converting a traditional IRA into a Roth IRA. While this provision does not apply until 2010, now may be a good time to make plans to maximize this opportunity.

The Roth IRA has benefits that are especially useful to high-income taxpayers, yet as a group they have been denied those advantages up until now. Currently, you are allowed to convert a traditional IRA to a Roth IRA only if your AGI does not exceed $100,000. A married taxpayer filing a separate return is prohibited from making a conversion. The amount converted is treated as distributed from the traditional IRA and, as a consequence, is included in the taxpayer's income, but the 10-percent additional tax for early withdrawals does not apply.

Significant benefits

While recognizing income sooner rather than later is usually not smart tax planning, in the case of this new opportunity to convert a traditional IRA to a Roth IRA, the math encourages it. The difference is twofold:

All future earnings on the account are tax free; and
The account can continue to grow tax free longer than a traditional IRA without being forced to be distributed gradually after reaching age 70 ½.

These can work out to be huge advantages, especially valuable to individuals with a degree of accumulated wealth who probably won't need the money in the Roth IRA account to live on during retirement.

Example. Mary's AGI in 2010 is $200,000 and she has traditional IRA balances that will have grown to $300,000. Assuming a marginal federal and local income tax of about 40 percent on the $300,000 balance, the $180,000 remaining in the account can grow tax free thereafter, with distributions tax free. Further assume that Mary is 45 years of age with a 90 year life expectancy and money conservatively doubles every 15 years. She will die with an account of $1.44 million, income tax free to her heirs. If the Roth IRA is bequeathed to someone in a younger generation with a long life expectancy, even factoring in eventual required minimum distributions, the amount that can continue to accumulate tax free in the Roth IRA can be staggering, eventually likely to reach over $10 million.

Planning strategies

Now is not too early to start planning to take advantage of the Roth IRA conversion opportunity starting in 2010. While planning to maximize the conversion will become more detailed as 2010 approaches and your assets and income for that year are more measurable, there are certain steps you can start taking now to maximize your savings.

Start a nondeductible IRA

The income limits on both kinds of IRAs have prevented higher income taxpayers from making deductible contributions to traditional IRAs or any contributions to Roth IRAs. They could always make nondeductible contributions to a traditional IRA, but such contributions have a limited pay-off (no current deduction, tax on account income is deferred rather than eliminated, required minimum distributions).

While a taxpayer could avoid these problems by making nondeductible contributions to a traditional IRA and then converting it to a Roth IRA, this option was not available for upper income taxpayers who would have the most to benefit from such a conversion. With the elimination of the income limit for tax years after December 31, 2009, higher income taxpayers can begin now to make nondeductible contributions to a traditional IRA and then convert them to a Roth IRA in 2010. In all likelihood, there will be little to tax on the converted amount.

What's more, taxpayers with $100,000-plus AGIs should consider continue making nondeductible IRA contributions in the future and roll them over into a Roth IRA periodically. As a result, the elimination of the income limit for converting to a Roth IRA also effectively eliminates the income limit for contributing to a Roth IRA.

Example. John and Mary are a married couple with $300,000 in income. They are not eligible to contribute to a Roth IRA because their AGI exceeds the $160,000 Roth IRA eligibility limit. Beginning in 2006, the couple makes the maximum allowed nondeductible IRA contribution ($8,000 in 2006 and 2007, and $10,000 in 2008, 2009, and 2010). In 2010, their account is worth $60,000, with $46,000 of that amount representing nondeductible contributions that are not taxed upon conversion. The couple rolls over the $60,000 in their traditional IRA into a Roth IRA. They must include $14,000 in income (the amount representing their deductible contributions), which they can recognize either in 2010, or ratably in 2011 and 2012.

Assuming they have sufficient earned income each year thereafter (until reaching age 70 1/2), John and Mary can continue to make the maximum nondeductible contributions to a traditional IRA and quickly roll over these funds into their Roth IRA, thereby avoiding significant taxable growth in the assets that would have to be recognized upon distribution from a traditional IRA.

Rollover 401(k) accounts

Contributions to a Section 401(k) plans cannot be rolled over directly into a Roth IRA. The lifting of the $100,000 AGI limit does not change this rule. However, they often can be rolled over into a traditional IRA and then, after 2009, converted into a Roth IRA.

Not everyone can just pull his or her balance out of a 401(k) plan. A plan amendment must permit it or, more likely, those who are changing jobs or are otherwise leaving employment can choose to roll over the balance into an IRA rather than elect to continue to have it managed in the 401(k) plan.

For money now being contributed to 401(k) plans by employees, an even better option would be for those contributions to be made to a Roth 401(k) plan. Starting in 2006, as long as the employer plan allows for it, Roth 401(k) accounts may receive employee contributions.

Gather those old IRA accounts

Many taxpayers opened IRA accounts when they were first starting out in the work world and their incomes were low enough to contribute. Over the years, many have seen those account balances grow. These accounts now may be converted into Roth IRAs starting in 2010, regardless of income.

Paying the tax

In spite of all the advantages of a Roth IRA, a conversion is advisable only if the taxpayer can readily pay the tax generated in the year of the conversion. If the tax is paid out of a distribution from the converted IRA, that amount is also taxed; and if the distribution counts as an early withdrawal, it is also subject to an additional 10-percent penalty. For those planning to convert who may not already have the funds available, saving now in a regular bank or brokerage account to cover the amount of the tax in 2010 can return an unusually high yield if it enables a Roth IRA conversion in 2010 that might not otherwise take place.

Careful planning is key

Transferring funds between retirement accounts can carry a high price tag if it is done incorrectly. For those who plan carefully, however, converting from a traditional IRA to a Roth IRA can yield very substantial after-tax rates of return. Please feel free to call our offices if you have any questions about how the 2010 conversion opportunity should fit into your overall tax and wealth-building strategy.

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The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work

The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work.

If you did not owe AMT last year, you still may be at risk. The IRS estimates that half million more individuals will be subject to the AMT in 2006 because of rising deductions and exemptions. If Congress doesn't extend the same AMT exclusion amount given in 2005, an estimated 3 million more taxpayers will pay AMT.

For a system that was intended originally to target only the very rich, the AMT now hits many middle to upper-middle class taxpayers as well. Obviously something has to be done, and will be, eventually, through proposed tax reform measures. In the meantime, expect AMT to be around for at least another year.

Basic calculations. Whether you will be liable for the AMT depends on your combination of income, adjustments and preferences. After all the computations, if your AMT liability exceeds your income tax liability, you will be liable for the AMT. Here are the basic steps to take to determine in evaluating whether you will owe the AMT:

Step #1: Calculate your regular taxable income. If your regular tax were to be determined by reference to an amount other than taxable income, that amount would need to be determined and used in the next steps.
Step #2: Calculate your alternative minimum taxable income (AMTI) by increasing or reducing your regular taxable income (or other relevant amount) by applying the AMT adjustments or preferences. These include business depreciation adjustments and preferences, loss, timing and personal itemized deductions adjustments, and tax-exempt or excluded income preferences. This is the step with potentially many sub-computations in determining increases and reductions in tax liability.
Step #3: If your AMTI exceeds the applicable AMT exemption amount, pay AMT on the excess.

While no single factor will automatically trigger the AMT, the cumulative result of several targeted tax benefits considered in Step #2, above, can be fatal. Common items that can cause an "ordinary" taxpayer to be subject to AMT are:

All personal exemptions (especially of concern to large families);
Itemized deductions for state and local income taxes and real estate taxes;
Itemized deductions on home equity loan interest (except on loans used for improvements);
Miscellaneous Itemized Deductions;
Accelerated depreciation;
Income from incentive stock options; and
Changes in some passive activity loss deductions.

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Starting for tax year 2005, businesses have been able to take a new deduction based on income from manufacturing and certain services. Congress defined manufacturing broadly, so many businesses -just not those with brick and mortar manufacturing plants-- will be able to claim the deduction. The deduction is 3 percent of net income from domestic production for 2005 and 2006. This percentage rises to 6 percent and then 9 percent in subsequent years.

Domestic production includes the manufacture of tangible personal property and computer software in the U.S. It also includes construction activities and services from engineering and architecture. Income from these activities must be calculated on an item-by-item basis and cannot be determined by division, product line or transaction. Direct and indirect costs are subtracted to determine "qualified production income." Land does not qualify as domestic production property.

The 3 percent rate is applied to the lower of net income from domestic production and overall net income. That amount is then capped at 50 percent of wages paid out by the employer for all its business activities.

Example. In 2005, Company X has $300,000 of income from domestic production activities. The company's overall net income was $500,000. The 3 percent rate is applied to $300,000, yielding a potential deduction of $9,000.

Company X paid its employees $50,000 in wages and reported this amount on Forms W-2 for 2005. Since the deduction is limited to 50 percent of wages paid and reported, Company X's deduction for 2005 is capped at $25,000 (50 percent of $50,000 in wages). X is entitled to a $9,000 deduction.

W-2 wage limitation

In some cases, the W-2 wage limit can easily trip up taxpayers. A successful sole proprietor who earns income but has no employees would not have any W-2 wages and, therefore, could not take the deduction. Self-employment income is not treated as wages. Neither are payments made to independent contractors. A small business that is incorporated but has no employees would have the same problem. Because payments to partners are not W-2 wages, a partnership with two partners and no employees also would be unable to take the deduction. Sole proprietors and other small businesses may want to consider putting a family member on the payroll, so that they have W-2 wages to satisfy this requirement.

An incorporated business, such as an S corporation, could put an owner on the payroll and apply the W-2 limit to reasonable wages paid to the owner. Employees include officers of the corporation and common law employees, as defined in the Tax Code. The more labor-intensive the manufacturing process, the more likely that a deduction will not be reduced by the W-2 wage limitation. The more automated the manufacturing process, the more likely it is that the manufacturer will find itself restricted by the wage limitation and not be able to take the full manufacturing deduction.

Code Sec. 199 defines W-2 wages as the sum of the total W-2 wages reported on Forms W-2, "Wage and Tax Statement," for the calendar year ending during the employer's taxable year. W-2 wages are defined as wages and deferred salary that is included on Form W-2. Deferred salary includes elective deferrals for a 401(k) plan or tax-sheltered annuity; contributions to a plan of a state and local government or tax-exempt entity; and designated Roth IRA contributions. IRS guidance provides three methods for calculating W-2 wages.

Our office can help you determine your eligibility for the manufacturing deduction and the amount of the deduction. Give us a call today.

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