Tax Court addresses Section 199 benefits and burdens test in contract manufacturing context

November 2013


The US Tax Court has released its long-awaited decision in ADVO v. Commissioner, 141 T.C. No. 9 (2013), finding in favor of the IRS.  In a case of first impression, the court addressed how Section 199 applies to taxpayers that manufacture products through agreements with contract manufactures.  Acknowledging the factually specific nature of the “by the taxpayer” requirement included in the final Section 199 regulations (the regulations), the court used a list of nine factors to determine whether ADVO had the benefits and burdens of ownership (B&B) of the property during the manufacturing process, noting that no one factor was determinative.

These factors, which are based on Grodt & McKay v. Commissioner, 77 T.C. 1221 (1981), the Section 936 test, and an example in the regulations, reflect the court’s opinion that the holdings in cases decided under Section 263A are not binding for purposes of Section 199.

Taxpayers that currently are claiming a Section 199 deduction for production activities performed pursuant to a contract manufacturing arrangement should review the ADVO decision to determine the extent to which the facts of the case align with their particular circumstances.

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