Recently, the US Federal District Court for the Southern District of Iowa in Meredith Corp. v. United States, No. 4:17-cv-00385 (S.D. Iowa Mar. 20, 2020), held that a magazine publisher was entitled to refund of federal income tax based for the Internal Revenue Code (IRC) section 199 domestic production deduction based upon the printing services performed by a contract manufacturer. At issue in the case was whether the publisher qualified as a printer of magazines for purposes of IRC section 199 despite hiring third-party printers to print its magazines. The Internal Revenue Service (IRS) argued that the third-party printers, not the magazine publisher, had the “benefits and burdens of ownership,” and thus only the third-party printers were eligible for the IRC section 199 deduction. The case involved tax years 2006 through 2012. The Tax Cuts and Jobs Act repealed IRC section 199 domestic production deduction for tax years after 2018.
This was a fact intensive case, and required the Court apply an eight-factor “facts and circumstances” test—similar to the factors in Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237–38 (1981)—to determine who had the benefits and burdens of ownership throughout printing process. The district court listened to testimony (including experts), and reviewed the complex contracts that governed the printing services performed by the third-party printers on behalf of the magazine publisher. Pivotal to its decision in favor of granting a refund, the court found that the magazine publisher purchased its own paper from suppliers, and then shipped the paper, while retaining title, to the third-party printers who printed, bound and packaged the magazines according to the specification, directions and oversight of the magazine publisher. Although no one factor was dispositive, the court emphasized that the magazine publisher had considerable equity in the magazines, paying over $46 million for paper shipped to one printer, while the third-party printer’s ink and other physical supplies only cost about $10 million. Most of the factors weighed in favor of the magazine publisher or were neutral, so the court held that the magazine publisher had the benefits and burdens of ownership, and was entitled to the IRC section 199 domestic production activities deduction.
Practice Point: IRC section 199 has been mired with controversy since its enactment. The third-party manufacturing rule has been a focus of that controversy since the IRS won ADVO, Inc. v. Commissioner, 141 T.C. 298 (2013). We have written extensively on the IRC section 199 battleground:
- A Look at Tax Code Section 199’a Last Stand
- The IRS’s Assault on Section 199 (Computer Software) Doesn’t Compute
- IRS and Taxpayers Continue to Battle Over IRC Section 199 Deduction for Computer Software
- IRS Campaign Focuses on Definition of “Qualified Film” Under Section 199
- Federal Tax Cases to Watch in 2019
It remains to be seen whether the government will appeal its loss in Meredith. Taxpayers who continue to have IRC section 199 controversies will have to determine whether their facts are more like the taxpayer in ADVO or the taxpayer in Meredith. There are several cases with this issue docketed currently. It will be interesting to see how this decision informs a resolution in those cases.