The Section 199 Deduction & Your Dental Practice

Quite a few of our clients are dentists and many have started to use technology that allows them to manufacture their own crowns - as oppose to sending the impressions out to a lab.  For the dentists who use this in-house "manufacturing,"  it begs the question of whether or not they should receive the Section 199 Deduction ("Manufacturers Deduction") when determining their tax liability.  ​

The Deduction
To begin, Section 199 allows a deduction of 9% of the manufacturing profit that a business generates.  If your entire business is manufacturing, it’s pretty easy to calculate as you would simply take 9% of your net income.  If you are a dentist, it gets a bit more difficult.
 
The controversy is in calculating how much income a dentist derives from the manufacturing Should they use the full cost of a crown or should they use the price that they used to get crowns for from a lab?  This is a major issue because a dentist may charge $1,000 for a crown, but a lab may only charge $250 for "manufacturing" it.  The difference in price is to compensate the dentist for their technical skills to install the crown. 
 
The current IRS law allows the credit for the manufacturing and installation of "something"; thus under a pure reading of the law, the dentist should be able to use their full price in determining the amount.  In our opinion, and until the law is further clarified, the full cost of the crown should be used to calculate the revenues.  But understand that, at any time, the IRS may reverse this in the future.
 
So the dentist would use the full price of the crown as the starting point in determining the income- but then must pull out the expenses associated with the manufacturing.  This would include wages and direct costs paid to run the machine, indirect costs, and depreciation.  For the wages, we believe the safe play would be to do the following: if we assume an office derives 20% of its income from crowns, it would be prudent to allocate 20% of the wages paid to the dentist and the assistant to the expense side of the calculation.
 
Direct costs are easy to determine.  Anything needed to directly run the machine like software and materials should be included.  Indirect costs, such as rent and professional services , should be allocated based on the percentage of income that is being derived from the production of crowns. Lastly, the depreciation expense on the machine should be added.  With new machines costing near $150,000 the depreciation deduction can be large - especially if Section 179 is used. 
 
Our Take
It is our opinion that putting the time in to calculate and keep the records for the deduction is worth it - in particular when a practice has minimal other depreciation left.  If you are still depreciating the asset and you’re not doing a massive amount of crowns, there likely isn’t much income associated with the manufacturing.   In this case, jumping through extra hoops may not be worth it. 

Finally, it is hard to say with any certainty how “safe” the deduction is for a dentist.  My gut tells me that this law was not intended for dentist and that at some point the IRS may seek to clarify it.  That said, until they do, we believe it is a safe deduction to take.