The Cheesecake Factory Inc. petitioned the Tax Court to dispute the amount of the domestic production deduction the IRS denied as preparation activities for adding whipped cream and garnish to cheesecake slices.
The petition revolves around a notice of deficiency issued to the Cheesecake Factory for almost $3 million for tax years 2010 through 2012 based on a reduction in its qualified production activities income (QPAI) eligible for the domestic production deduction under section 199.
The Cheesecake Factory disputed the IRS’s determinations that some of the QPAI was for preparation of slices of cheesecake at its retail restaurants and that any preparation was more than de minimis.
Even if the IRS was correct about both of those determinations, it shouldn’t have attributed half of the price of a slice of cheesecake to in-store preparation, the Cheesecake Factory said. Instead, the IRS should have only excluded 2 to 4 percent of the price from QPAI, according to the petition, which notes that there’s “no price difference between slices sold with and without garnish or whipped cream.”
The domestic production deduction brought substantial controversy to seemingly small activities. In United States v. Dean, 945 F. Supp.2d 1110 (C.D. Cal. 2013), the IRS and the taxpayer disagreed over whether the process of assembling “gift towers” from other items qualified for the deduction. Precision Dose Inc. v. United States, No. 3:12-cv-50180 (N.D. Ill. 2015), was a similar case involving reselling drugs in “unit doses.” The IRS lost both district court cases.
An IRS Large Business and International Division directive (LB&I-04-0315-001) from 2015 listed activities that don’t qualify for the domestic production deduction under section 199. Those activities were “(1) cutting blank keys to a customer’s specification; (2) mixing base paint and a paint coloring agent; (3) applying garnishments to cake that is not baked where sold; (4) applying gas to agricultural products to slow or expedite fruit ripening; (5) storing agricultural products in a controlled environment to extend shelf life; and (6) maintaining plants and seedlings.”
Section 199 was repealed for tax years starting after January 1, 2018, by the Tax Cuts and Jobs Act (P.L. 115-97).
The Cheesecake Factory is being represented by Fenwick & West LLP.