The IRS has concluded in a recent legal memorandum (ILM 201313020) that a taxpayer's activities related to producing an electronic version of a book did not result in qualified production property under Section 199(c)(5)(A). The ILM focused specifically on the taxpayer's activities to prepare the book for physical publishing, which was done by a contract manufacturer. The ILM did not address whether the taxpayer had the benefits and burdens of ownership during the contract manufacturing.
The taxpayer's activities related to the books it sold included market research, resource planning, content and layout development, and editing. Those activities allowed the taxpayer to create an electronic version of a book that contained exact electronic displays of each page. The taxpayer would then give the contract manufacturer those electronic displays, along with print specifications, for the publishing of the physical books. The IRS concluded that although the taxpayer's activities produced something of value, the product was intangible rather than tangible.
A Section 199 deduction is available for qualified property produced in the United States. Qualified property includes tangible personal property, computer software and sound recordings. Therefore, the IRS concluded, because the taxpayer was creating intangible property that was not computer software or a sound recording, the electronic form of the book was not qualified property for purposes of Section 199.
The IRS noted that even though the taxpayer was subject to the Section 263A inventory capitalization rules, the treatment of the production of books is inconsistent between Sections 263A and 199. Section 263A "includes the costs of the taxpayer's activities that create intangible aspects of a book as costs related to the production of tangible personal property," the IRS said. In contrast, Section 199 treats the underlying manuscript and an online version of a book as nonqualifying intangible property. That conclusion essentially separates the activities leading up to the physical production of the books from the actual publishing of the books.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.