The domestic production activities deduction under IRC 199 provides a tax benefit for certain domestic production activities. In particular, IRC 199 allows a deduction equal to a specified percentage of the taxpayer's qualified production activities income for the tax year. The specified percentage is 6% for 2008-2009, and 9% thereafter.

The deduction is available to corporations, individuals, estates, and trusts that are engaged in certain domestic trade or business activities. For pass-through entities, including partnerships, limited liability corporations taxed as partnerships, and S corporations, the deduction is based on the activities of the pass-through entity but is computed at the individual partner, member, or shareholder level. Taxpayers use federal Form 8903 to compute the deduction.

Under the MBT, for taxpayers other than insurance companies and financial institutions, the business income tax comprises a portion of the total tax liability and is calculated by multiplying the business income tax base after apportionment by the applicable rate. "Business income tax base" means "a taxpayer's business income subject to" certain adjustments. MCL 208.1201. "Business income" means "that part of federal taxable income derived from business activity." MCL 208.1105. "Federal taxable income" means "taxable income as defined in [IRC 63]." MCL 208.1109. Federal taxable income is determined under IRC 63 by subtracting the IRC 199 deduction from gross income. For partnerships (including limited liability companies taxed as partnerships) and S corporations, business income also includes "payments and items of income and expense that are attributable to business activity of the partnership or S corporation and separately reported to the partners or shareholders." MCL 208.1105.

Corporations. For taxpayers taxed as corporations, federal taxable income includes the IRC 199 deduction. In other words, for federal corporate return purposes, the domestic production activities deduction (Form 1120, line 25) is used to calculate (and reduce) federal taxable income (Form 1120, line 30). In turn, business income for MBT purposes is reduced. No MBT provision specifically disallows corporations from taking IRC 199 deductions, nor is there a provision that requires any IRC 199 deduction to be added back to business income. Thus, MBT taxpayers taxed as corporations that qualify for an IRC 199 deduction on their federal tax return will automatically experience a corresponding reduction in its MBT business income tax base and resulting MBT liability.

Pass-Through Entities. Federal taxable income for pass-through entities is determined under IRC 703 and 1363. Business income includes "payments and items of income and expense that are attributable to business activity of the partnership or S corporation and separately reported to the partners or shareholders." MCL 208.1105.

By its express terms, IRC 199 does not apply at the entity level with regard to pass-through entities and is not included in the federal taxable income of the entity. See IRC 199(d)(1)(A). Furthermore, IRC 199 is not an item of income or expense separately stated under IRC 702(a). See IRC 199, 703, and 1363. Rather, pass-through entities must directly report to shareholders, members, or partners each item of information needed to calculate the domestic production activities deduction at the shareholder, member, or partner level. Thus, the domestic production activities deduction is not applicable to pass-through entities for MBT purposes; rather, the IRC 199 deduction is taken at the shareholder, member, or partner level for Michigan income tax purposes.