The Tax Cuts and Jobs Act (the “Act”) made effective on December 22, 2017 repealed the old section 199 of the Internal Revenue Code of 1986 (the “Code”) which used to provide for an income tax deduction equal to approximately 9 percent of the “qualified production activities income” from the taxpayer’s domestic production (“DPAD”) subject to 50 percent W-2 wage limitation. Instead, the Act has introduced a new section 199A of the Code providing for a new income tax deduction to unincorporated taxpayers approximately equal to 20 percent of the taxpayer’s “qualified business income,” with respect to certain qualified trade or business excluding certain specified service trade or business. This deduction is also subject to a limitation based on the greater of 50 percent of W-2 wages with respect to the qualified trade or business or the sum of 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis of all qualified property. In addition, section 199A introduced by the Act, as enacted originally (the “Old 199A”), also allowed additional deduction of 20 percent of the “qualified cooperative dividends” that a cooperative patron receives from a cooperative subject to taxation under Subchapter T (of Chapter 1, of Subtitle A) of the Code without being subject to the wage or capital limitation. On March 23, 2018, the Consolidation Appropriations Act of 2018 was signed into law providing for technical corrections to the Act including the portion of the Old 199A allowing the additional 20 percent of the qualified cooperative dividends and replacing it with a set of new provisions of section 199A (the “New 199A”) that provides for additional deduction to specified agricultural or horticultural cooperatives and their patrons that is similar but not identical to (or better or greater than) DPAD (the “Coop Fix Legislation”). This article introduces brief discussions on: (i) how these multiple levels of tax deductions under the New 199A may impact or benefit farmers and farming business entities, (ii) what issues need to be considered to take the most advantage of the New 199A, and (iii) whether or not transacting with or through agricultural cooperative still provides for additional benefit to the producers of agricultural products even after the Coop Fix Legislation.
I. Eligible Taxpayers and Trade/Business.
a. Unincorporated Taxpayers. The deductions under the New 199A are available for taxpayers who are engaged in qualified trade or business as a sole proprietor or partnership. Also those deductions are available to S corporations. However, C corporations are not eligible for those deductions under the New 199A. Instead, under the Act, C corporations received their tax rate reduction from a top rate of 35 percent to a flat rate of 21 percent and, understandably, the New 199A has been enacted to provide tax benefits to unincorporated taxpayers corresponding to the rate reduction made solely for C corporations.
b. Non-Service Trade/Business; Exception. In order to be eligible for the New 199A deductions, the taxpayer should be engaged in a “qualified trade or business.” A qualified trade or business is “any trade or business” other than: (A) a specified service trade or business; or (B) the trade or business of performing services as an employee. Under the New 199A, the excluded “specified service trade or business” means (x) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners; or (y) any trade or business which involves the performance of services that consist of investing and investment management, trading, or dealing in securities (which includes futures contracts, swaps, and financial derivatives). This exclusion is subject to exception based on the taxpayer’s taxable income (i.e., the specified service trade or business exclusion does not apply if the taxable income is below $157,500 for single return filers and $315,000 for joint return filers). In general, most farming trade or business involving the production of agricultural commodities will be eligible for the deduction sunder the New 199A. Eligibility issues may arise concerning the following areas in agriculture:
(i) Owner Compensation. If a partner of a farm partnership receives a guaranteed payment from a farm partnership in exchange for such partner’s service as an employee of the farm partnership or if a shareholder of a farming S corporation receives wages (including, commodity wages) from the S corporation, the guaranteed payments and wages will not be eligible for deduction under the New 199A. Subsection (c)(4) of the New 199A specifically excludes the following from “qualified business income” :
(A) reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business;
(B) any guaranteed payment described in section 707(c) of the Code paid to a partner for services rendered with respect to the trade or business, and
(C) to the extent provided in regulations, any payment described in section 707(a) of the Code to a partner for services rendered with respect to the trade or business.
(ii) Ag Engineering/Architect Services. Any trade or business characterized as engineering or architecture services provided by a farming entity or a construction subsidiary or affiliate of a farming entity will not qualify as the qualified trade or business under the New 199A and any items of income, gain, deduction, or loss from engineering or architecture services will not be considered in determining the deductions available under the New 199A.
(iii) Marketing Services. Business income from purely marketing function (i.e., entering into a procurement agreement with a meat packer, performing as a grain broker) performed by a farming entity or a separate subsidiary or affiliate of a farming entity does not qualify for the deductions under the New 199A.
(iv) Risk Management Services. Business income from risk management services (i.e., managing lean hog futures, spreads, swaps, etc.) performed by a farming entity or a separate subsidiary or affiliate of a farming entity does not qualify for the deductions under the New 199A.
II. Deductions under New 199A. For the taxpayers in agriculture, there are three categories of deductions provided under the New 199A:
a. 20 Percent QBI Deduction / 11 Percent QBI Deduction. In general, with respect to each and every qualified trade or business, each determined separately first and combined later, an eligible taxpayer under the New 199A is entitled to a deduction in the amount of 20 percent of the taxpayer’s “qualified business income from the qualified trade or business” (the “QBI Deduction”) “Qualified business income” (“QBI”) means, in general, the net amount of qualified items of income, gain, deduction, and loss effectively connected with the conduct of a trade or business within the United States. The QBI Deduction is limited and reduced as follows:
(i) First Tier Limitation; Exception: The QBI Deduction is first limited to the greater of: (A) 50 percent of the W-2 wages with respect to the qualified trade or business or (B) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property (the “Wage/Investment Limitation”). However, the Wage/Investment Limitation does not apply to any taxpayer whose taxable income for the taxable year does not exceed $157,500 for single return filers and $315,000 for joint return filers, which amount will be increased after 2018 based on a cost-of-living adjustment. Also, taxpayers with taxable income in excess of the threshold amount up to $50,000 for single return filers and $100,000 for joint filers may still get some deduction subject to the phase-in of such limit based on the degree of such excess.
(ii) Second Tier Limitation: The QBI Deduction is further limited to the lesser of: (A) the QBI and (B) 20 percent of the excess (if any) of the taxable income of the taxpayer for the taxable year over the sum of any net capital gain of the taxpayer for the taxable year (the “Capital Gain Exclusion”). The Capital Gain Exclusion is designed to disallow any deduction under the New 199A for a taxable income that is taxed as the capital gains rate which is lower than ordinary income tax rate.
(iii) Cooperative Payment Reduction: In case of any taxpayer who receives qualified payments from a specified agricultural or horticultural cooperative, the general QBI Deduction (i.e., 20 percent of QBI) shall be reduced by the lesser of: (A) 9 percent of so much of the QBI with respect to such trade or business as is properly allocable to qualified payments received from such cooperative or (B) 50 percent of so much of the W-2 wages with respect to such trade or business as are so allocable. Accordingly, to the QBI Deduction allocable to such coop payments is 11 percent instead of 20 percent.
b. 9 Percent QPAI Deduction to Ag Coops. By the Coop Fix Legislation, a new subsection (g) was added to the New 199A providing for a deduction to a “specified agricultural or horticultural cooperative” equal to 9 percent of the “qualified production activities income” of the taxpayer for the taxable year (the “QPAI Deduction”). “Qualified production activities income” (“QPAI”) means an amount equal to the excess of the taxpayer’s “domestic production gross receipts” over the sum of the cost of goods sold and other expenses, losses, or deductions allocable to such receipts. “Domestic production gross receipts” means the gross receipts of the taxpayer which are derived from any lease, rental, license, sale, exchange, or other disposition of any agricultural or horticultural product which was manufactured, produced, grown, or extracted by the taxpayer in whole or significant part within the United States except: (i) any gross receipts from the lease, rental, license, sale, exchange, or other disposition of land” and (ii) any gross receipts of the taxpayer derived from property leased, licensed, or rented by the taxpayer for use by any related person. “Specified agricultural or horticultural cooperative” means an organization to which part I of subchapter T of the Code applies which is engaged in (x) the manufacturing, production, growth, or extraction in whole or significant part of any agricultural or horticultural product, or (y) the marketing of agricultural or horticultural products. In determining whether a specified agricultural or horticultural cooperative has manufactured, produced, grown, or extracted any agricultural or horticultural product, the New 199A provides that the specified agricultural or horticultural cooperative “shall be treated as having manufactured, produced, grown, or extracted” the agricultural or horticultural product marketed by the specified agricultural or horticultural cooperative which “its patrons have so manufactured, produced, grown, or extracted.”
(i) First Tier Limitation: The QPAI Deduction is first limited to the 50 percent of the W-2 wages of the specified agricultural or horticultural cooperative.
(ii) Second Tier Limitation: The QPAI Deduction is also limited to the lesser of: (A) the QPAI and (B) the taxable income of the taxpayer for the taxable year.
c. QP Deduction to Coop Patrons. Any “eligible taxpayer” who receives a “qualified payment” from a specified agricultural or horticultural cooperative is entitled to a deduction (the “QP Deduction”) in an amount equal to the portion of the QPAI Deduction which is (i) allowed with respect to the QPAI to which such qualified payment is attributable (the “QP”) and (ii) identified by such cooperative in a written notice mailed to such taxpayer during the payment period beginning with the 1st day of such taxable year and ending with the 15th day of the 9th month following the close of such year. “Eligible taxpayer” here means a taxpayer other than a C corporation or a specified agricultural or horticultural cooperative. “Qualified payment” means a patronage dividend, qualified written notice of allocation, per-unit retain allocation paid in qualified per-unit retain certificates, and other property received from a specified agricultural or horticultural cooperative attributable to the QPAI with respect to which the QPAI Deduction is allowed to such cooperative.
(i) Limitation: The QP Deduction is limited to the taxable income of the taxpayer determined without regard to the QP Deduction and after taking into account any QBI Deduction allowed to the taxpayer.
III. Agricultural Cooperatives. So, will transacting with or through agricultural cooperative still provide for additional benefits to the producers of agricultural products even after the Coop Fix Legislation? It appears that there could be some tax advantages in transacting with or through agricultural cooperatives subject to certain qualifications.
a. Size of Coop Payment Reduction. As discussed above, the reduction of the QBI Deduction under the New 199A (26 U.S.C. § 199A(b)(7)) is by 9 percent of the QBI whereas the QP Deduction that the taxpayer dealing with an agricultural cooperative receives may be 9 percent of the QPAI. To simply put, the reduced 9 percent of the QBI is a net income determined at the farmer/taxpayer who produces and delivers agricultural products to the cooperative, subject to 50 percent of the W-2 wages of the farmer. On the other hand, the 9 percent QP Deduction made available to the taxpayer delivering products to the cooperative is based on the QPAI, which is the cooperative’s net income, and is subject to the 50 percent of the W-2 wages of the cooperative. For instance, the reduction amount under 26 U.S.C. § 199A(b)(7)) is $0 if the W-2 wages of the farmer is $0 (i.e., sole proprietor). Likewise, it is possible that the amount of the reduced 9 percent of the farmer’s QBI may be less than the QP Deduction made available or pushed down from the cooperative. Accordingly, there will be a situation where the farmer may qualify for the full 20 percent QBI Deduction plus the QP Deduction flown from the cooperative.
b. Example #1. Farmer Joe is farming corn in 2018 as his sole trade and business and will incur no wages to third parties. Assume Farmer Joe’s taxable income and QBI determined without considering the QBI Deduction is $500,000 for 2018. Assume Farmer Joe may receive a QP Deduction of $50,000 if he delivers certain amount of corn to a local cooperative. If Farmer Joe decides to sell corn to a non-cooperative buyer, the QP Deduction is not available. Under these assumptions, Farmer Joe will be better off by selling corn to the cooperative:
Case #1: Delivery to Coop: The total deduction available to Farmer Joe for 2018 is $150,000, which is the sum of $100,000, the QBI Deduction (20% of $500,000) plus $50,000 QP Deduction.
Case #2: Delivery to Non-Coop: The total deduction available to Farmer Joe for 2018 is $100,000, which is the sum of $100,000, the QBI Deduction (20% of $500,000).
c. Example #2. Farmer Sam is farming corn in 2018 as his sole trade and business and will incur wages to third parties in the amount of $100,000. Assume Farmer Sam’s taxable income and QBI determined without considering the QBI Deduction is $500,000 for 2018. Assume Farmer Sam may receive a QP Deduction of $50,000 if he delivers certain amount of corn to a local cooperative. If Farmer Sam decides to sell corn to a non-cooperative buyer, the QP Deduction is not available. Under these assumptions, Farmer Sam will be better off by selling corn to the cooperative:
Case #1: Delivery to Coop: The total deduction available to Farmer Sam for 2018 is $105,000, which is the sum of $55,000, the QBI Deduction (11% of $500,000) plus $50,000 QP Deduction.
Case #2: Delivery to Non-Coop: The total deduction available to Farmer Sam for 2018 is $100,000, which is the sum of $100,000, the QBI Deduction (20% of $500,000).
d. Example #3. Farmer Tom is farming corn in 2018 as his sole trade and business and will incur wages to third parties in the amount of $100,000. Assume Farmer Tom’s taxable income and QBI determined without considering the QBI Deduction is $500,000 for 2018. Assume Farmer Tom may receive a QP Deduction of $30,000 if he delivers certain amount of corn to a local cooperative. If Farmer Tom decides to sell corn to a non-cooperative buyer, the QP Deduction is not available. Under these assumptions, Farmer Tom will be worse off by selling corn to the cooperative:
Case #1: Delivery to Coop: The total deduction available to Farmer Tom for 2018 is $85,000, which is the sum of $55,000, the QBI Deduction (11% of $500,000) plus $30,000 QP Deduction.
Case #2: Delivery to Non-Coop: The total deduction available to Farmer Tom for 2018 is $100,000, which is the sum of $100,000, the QBI Deduction (20% of $500,000).
e. Example #2. Farmer Mike is farming corn in 2018 as his sole trade and business and will incur wages to third parties in the amount of $70,000. Assume Farmer Mike’s taxable income and QBI determined without considering the QBI Deduction is $500,000 for 2018. Assume Farmer Mike may receive a QP Deduction of $40,000 if he delivers certain amount of corn to a local cooperative. If Farmer Mike decides to sell corn to a non-cooperative buyer, the QP Deduction is not available. Under these assumptions, Farmer Mike will be better off by selling corn to the cooperative:
Case #1: Delivery to Coop: The total deduction available to Farmer Mike for 2018 is $105,000, which is the sum of $65,000, the QBI Deduction ($100,000 (=20% of $500,000) less $35,000 (50% of wages)) plus $40,000 QP Deduction.
Case #2: Delivery to Non-Coop: The total deduction available to Farmer Mike for 2018 is $100,000, which is the sum of $100,000, the QBI Deduction (20% of $500,000).
This information is general in nature and should not be construed for tax or legal advice.
1 An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, P.L. 115-97.
2 26 U.S.C. § 199A(a).
3 26 U.S.C. § 199A(b)(2)(B).
4 See 26 U.S.C. § 199A(a)(“In the case of a taxpayer other than a corporation…”)(emphasis added).
5 26 U.S.C. § 199A(d)(1).
6 Id.
7 26 U.S.C. § 199A(d)(2); 26 U.S.C. § 1202(e)(3)(A); 26 U.S.C. § 475(c)(2).
8 26 U.S.C. § 199A(d)(3).
9 26 U.S.C. § 199A(c)(4).
10 26 U.S.C. § 199A(a).
11 26 U.S.C. § 199A(c).
12 26 U.S.C. § 199A(b)(2)(B).
13 26 U.S.C. § 199A(b)(3)(A) and (e)(2).
14 26 U.S.C. § 199A(b)(3)(B).
15 26 U.S.C. § 199A(a).
16 26 U.S.C. § 199A(b)(7).
17 26 U.S.C. § 199A(g)(1)(A).
18 26 U.S.C. § 199A(g)(3)(A).
19 26 U.S.C. § 199A(g)(3)(D)(i).
20 26 U.S.C. § 199A(g)(3)(D)(ii)(I).
21 26 U.S.C. § 199A(g)(4)(A).
22 26 U.S.C. § 199A(g)(4)(B).
23 26 U.S.C. § 199A(g)(1)(B)(i).
24 26 U.S.C. § 199A(g)(1)(A)(ii).
25 26 U.S.C. §§ 199A(g)(2)(A) and 1382(d).
26 26 U.S.C. § 199A(g)(2)(D).
27 26 U.S.C. § 199A(g)(2)(E).
28 26 U.S.C. § 199A(g)(2)(B).
