Insight Center: Publications

New GLAM Might Provide Opportunity on Prior Period Expenses for Section 199

Tax Update

Author: Todd B. Reinstein


Over the past several years, a great deal has been discussed regarding the implementation of Section 199,1 which allows a deduction equal to a percentage of a taxpayer’s income attributable to domestic production activities.2 Recent IRS guidance may provide an opportunity to increase the deduction for prior years, and claim a refund of prior taxes.

For taxable years beginning in 2010 and thereafter, the deduction is equal to 9 percent of the lesser of a taxpayer’s "qualified production activities income" (QPAI) or taxable income (modified adjusted gross income, in the case of individual taxpayers), determined without regard to the deduction. The deduction was phased in at 3 percent for taxable years beginning in 2005 and 2006 and 6 percent for years beginning in 2007 through 2009.3 QPAI for any taxable year is equal to the taxpayer’s "domestic production gross receipts" (DPGR), reduced by the sum of the cost of goods sold and below-the-line expenses allocable to DPGR. Thus, the more expenses allocated below the line to non-DPGR items the greater the QPAI and thus a greater Section 199 deduction.

One open issue with which taxpayers have been grappling is the proper method for allocating and apportioning prior period compensation expenses. That is, how does a current compensation expense, which was properly deferred from a prior period, affect a taxpayer’s current Section 199 calculation when the services performed relate to a prior period that might not relate to the current calculation of QPAI? On February 2, 2009, the IRS released a General Legal Advice Memorandum (GLAM) that attempts to answer this question by way of several examples that might provide some taxpayers with an opportunity to amend previous open years federal tax returns and report a greater QPAI, which gives rise to a greater deduction.4

Apportioning Section 199 Expenses

Reviewing the Section 199 expense allocation rules is appropriate in order to understand the potential benefit. Cost of goods sold expenses are matched to the DPGR to which they relate, regardless of the year in which they arose for Section 199 purposes.5 This rule applies, however, only to cost of goods sold items and not to below the line deductions. Below the line expenses are governed under the Section 861 rules unless the taxpayer qualifies for one of the simplified methods intended for small taxpayers. Under the Section 861 rules, deductions are allocated among groupings of income. For Section 199 purposes, these expenses are allocated between the two Section 199 classes, DPGR and non-DPGR. These allocations are done based on the factual relationships that source the expense, other than for interest and R&D. These rules did not, however, address the timing of the expenses, leaving taxpayers in the dark about how to allocate prior period compensation that was deferred.

Prior Guidance

Some taxpayers had relied on previous IRS guidance interpreting the sourcing rules in Section 861 even though the guidance was issued prior to the enactment of Section 199. The IRS concluded in Chief Counsel Advice 200215010 that it was reasonable for a U.S. corporation to apportion stock option expense deductions in determining its foreign sales corporation income also under Section 861.6 Here, it was reasonable for the corporation to relate its compensation expense to the period granting and vesting of the option since employees needed to continue performing services during the period.


The GLAM responds to a scenario of a U.S. manufacturer whose employee participated in a deferred compensation program prior to/and during years in which the corporation claimed a Section 199 deduction. The deduction for these expenses was not claimed until years after the services were performed. The IRS essentially concluded that to the extent the expenses related to goods that were sold in Section 199 years, even though the services were in prior years, they must be apportioned to DPGR in the years the goods were sold. The GLAM also concludes that prior period expenses that did not relate to DPGR are allocated to non-DPGR. To make the allocations, the GLAM points out that the taxpayer need only provide a reasonable method of allocation. But, it also points out that it is not realistic to allocate none of the deferred compensation to DPGR. The GLAM also provides examples covering several other types of deferred compensation, such as deferred bonuses and stock option deductions.

Pepper Perspective

The IRS probably issued the GLAM to prevent taxpayers from reducing their QPAI by removing the entire amount of prior period expenses. However, taxpayers who have not made any adjustments to their previous QPAI calculations to account for prior period compensation expenses might have an opportunity to increase their QPAI by removing certain compensation expenses from the calculation if they are similar to the scenarios described in the GLAM. Although many companies may not have the records to support the exact adjustments, the IRS seems willing to accept adjustments that are reasonable. Companies looking for cash might consider amending the previous open years’ tax returns to take advantage of the scenarios in the GLAM by increasing their QPAI and potentially claiming a refund.


1 Unless otherwise stated, all references to "Sec." are to the Internal Revenue Code of 1986 (the Code), and all references to "Reg. Sec." are to the Treasury Regulations promulgated thereunder (the Regulations).

2 The Sec. 199 deduction was the centerpiece of the American Jobs Creation Act of 2004, P.L. 108-357, § 102, 118 Stat. 1418 (Oct. 22, 2004).

3 Sec. 199(a)(2). Note that Section 199(d)(9) limits the percentage to 6 percent for taxpayers with oil related QPAI after 2009.

4 AM 2009-001 (February 2, 2009).

5 Treas. Reg. Section 1.199-4(b)(2)(ii).

6 CCA 200215010 (April 12, 2002).

Todd B. Reinstein

The material in this publication is based on laws, court decisions, administrative rulings and congressional materials, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.