Specifically, the IRS recently issued new guidance for claiming the manufacturing deduction in the form of Revenue Procedure 2007-35. The new ruling explains how your company can use a statistical sampling for this purpose.

However, don’t get overly excited. The new ruling isn’t a cure-all. It falls short of allowing such samplings on an industry-wide basis without the requisite proof for a company’s particular situation.

Background: The manufacturing deduction was created back in 2004 by the American Jobs Creation Act. Initially, the deduction was limited to the lesser of 3% of a company’s qualified production activity income (QPAI) or its taxable income. QPAI is based on domestic production gross receipts (DPGR) from qualified manufacturing activities.

The deduction percentage increased to 6% for the 2007 tax year. Currently, it is scheduled to top out at the 9% figure in 2010.

Note: The annual deduction is also limited to 50% of W-2 wages. Furthermore, qualified production activities must be performed in whole or in significant part in the United States.

Now the new IRS ruling provides for the use of a statistical sampling, thereby making it easier to claim the deduction. The new procedure provides details of several samplings the IRS would approve. Accordingly, the sampling may be used for:

*The allocation of gross receipts between DPGR and non-DPGR;

*A determination if gross receipts qualify as DPGR on an item-by-item basis;

*An allocation of cost of goods sold between DPGR and non-DPGR; and

*An allocation of deductions properly allocable to DPGR or gross income attributable to DPGR.

When does the new ruling take effect? The guidelines are generally effective for tax years beginning after May 10, 2007. However, a taxpayer can elect to apply the rules retroactively to tax years beginning after 2004. In any event, if you use statistical sampling for this purpose, the IRS can then use the statistics to challenge any part of your return.

The new procedure also outlines the technical requirements for statistical samplings. For instance, a sampling must be conducted in an “unbiased scientific manner,” and judgment sampling cannot be used. Some of the factors that may be used to determine if a statistical sample is appropriate are the time and cost of analyzing data and the availability of more accurate information.

Best approach: Consult with a tax expert for the application of the new rules to your situation.