The new tax law brought into play Section 199A (commonly known as the 20% pass-through deduction). Here’s a quick refresher.
The original law allowed most farmers to take a 20% deduction of net farm income off of their taxable income. However, farmers who sold their commodities to a cooperative could deduct 20% of their gross sales and the only limit was 100% of taxable income (after subtracting capital gain income).
This deduction was much greater than if the farmer sold to a private buyer, and thus a possibly large distortion in the grain market would occur.
Once Congress realized the issue, they invited the National Grain and Feed Association along with the National Council of Farmer Cooperatives to arrive at a solution to fix this “grain glitch.” After many sessions (our firm was involved in this process), a fix was created and the final law was passed on March 23, 2018.
Now What? To calculate their Section 199A deduction, farmers will need to:
• Calculate net income or loss from each business.
• If total taxable income is under a threshold amount, then they simply multiply net business income by 20%. If this is less than 20% of
taxable income (after subtracting capital gains), this is their Section 199A deduction.
• If their income is over the threshold amount ($207,500 or $415,000 for married couples), the deduction will be limited to the greater of 50% of wages paid by the farm or 25% of wages paid plus 2.5% of qualified depreciable property.
• If they sell products to a cooperative, they will need to reduce the Section 199A deduction by the lessor of 9% of net income attributable to those sales or 50% of wages paid.
If this sounds complicated, the actual calculations are even worse. For farmers who sell to cooperatives and their income is under the threshold amount, they likely would not want to pay wages. However, if they are over the threshold amount, not paying wages will reduce their regular Section 199A to simply being 2.5% of depreciable property.
How It Works. In 2018, John and Sue Farmer sell 50% of their grain to the local cooperative and receive a Section 199A deduction from the cooperative of $25,000. They net $300,000 on their Schedule F farm operation and paid $50,000 of wages to their hired man plus some labor to harvest their crop and have $1.5 million of qualifying property.
Let’s assume they are under the threshold amount. In this case, they simply take 20% of $300,000 ($60,000) and then add the $25,000 cooperative flow-through. This results in a gross deduction of $85,000. However, they then have to reduce their deduction by the lesser of $12,500 (50% of wages based on 50% of operations) or 9% of $150,000 ($13,500). Their final Section 199A deduction is now $72,500 ($60,000 $25,000 - $12,500).
Now let’s assume they are over the threshold amount. In this case, their Section 199A deduction will be limited to the greater of $25,000 (50% of wages paid) or $50,000 (25% of wages paid plus 2.5% of $1.5 million of qualifying property). Therefore, their regular Section 199A deduction is now $50,000, which reduces the final deduction to $75,000.
What if they paid no wages? If they are under the threshold amount, they get the full $85,000 deduction ($60,000 regular plus the $25,000 flow-through deduction from the cooperative). But, if they are over the threshold, the regular deduction is limited to $37,500 ($1.5 million x 2.5%) plus the $25,000 flow-through equals $62,500. They don’t get a reduction for the cooperative sales because they didn’t pay wages.
We should receive further guidance on this deduction from the IRS soon. This column simply summarizes how it works. Once we have the guidance I will write another column(s).
On a personal note, my wife and I took a photo safari trip to South Africa in May. Check out a short video and photos from our travels at bit.ly/NeifferInAfrica