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Additional Section 199A Guidance

Published on: 20:26PM Apr 01, 2018

We continue to get reader's questions on Section 199A and here are some additional questions and answers:

So all businesses are subject to the income thresholds?   The $157,500/$315,000 limits apply even if the business is not one of the specified services, such as attorneys and accountants. 

Also - has there been any mention of how the health care exchanges will be handling this for 2018? Many people applied for subsidies (I am thinking mostly dairy farmers with large DPADS included in AGI) and used their AGI from 2016 or 2017 that was reduced by DPADs.    Now when 2018 is actually filed, there will be many who will no longer qualify for the subsidies they received and will have to pay that back next spring.   Do you think this is a change in circumstances that should be reported to the exchanges?

Yes, all businesses will be subject to the income thresholds. If the business is a specified service business (SSB), there will be no Section 199A deduction allowed once taxable income if fully over the threshold amounts ($415,000 MFJ, half that for everyone else).  Farmers who are over the threshold may continue to retain all of their Section 199A deduction assuming 50% of wages paid or 25% of wages plus 2.5% of qualified property is higher.  Otherwise, it will be phased-out or fully limited once it reaches those same levels.

We had posted previously a couple of times that this deduction does not reduce AGI and may affect those that are on a state health insurance exchange and receiving subsidies.  It would be prudent to have your tax advisor calculate what your estimated Section 199A deduction might be and see how your AGI will be affected.

What is the deduction for non-patronage payments from a cooperative?

This income will simply be part of the regular Section 199A calculations. Many farmers sell some inventory to cooperatives without being a patron.  Patrons will need to allocate their income between cooperative and non-cooperative net farm income.

Expanding on your comment above regarding the 2.5%.  As I read it, the unadjusted basis is not reduced by any depreciation deductions but any asset that was fully depreciated prior to 2018 will not count towards basis.  With Section 179 and bonus depreciation, that will affect several farmers.  Also, since land will not qualify, unadjusted basis may not be as much as you would expect.

The amount of depreciation taken by the farmer on all assets will not affect the 2.5% calculation. All tangible property that has been held by the farmer for less than 11 years will qualify.  Also, any property held greater than 10 years but still being depreciated will also qualify (such as a farm building).  Unadjusted basis of all tangible property is used therefore depreciation and Section 179 is ignored.  This means the original cost basis of all farm assets (other than land) that meets these requirements will be used in the 2.5% calculation.  We need guidance from the IRS to determine how unadjusted basis is calculated for trade-ins and other like-kind exchanges.  Also, IRS guidance is needed for when a farmer liquidates his farm operation.

One caution is that this applied on a business by business basis (unless the IRS allows grouping). Therefore, you may have wages and no qualified property (QP) in one farm entity and QP and no wages in another (such as an equipment leasing company).  Once we get guidance from the IRS we will have a better idea on any required strategies.

Can you share an example with numbers from the co-op perspective as to how the pass through would be 50% of wages? My examples limit the deduction to the lesser amount of 9% of taxable income.

Let’s review an example assuming that taxable income for a married couple is under $315,000. The farmer receives a DPAD from the cooperative of $10,000 and has net farm income of $200,000.  He pays no wages.  His Section 199A deduction is $40,000 ($200,000 times 20%) minus the lessor of 9% of net farm income ($18,000) or zero (50% of zero is zero).  Therefore, the net Section 199A deduction is $50,000 ($10,000 Section 199A “DPAD” plus $40,000).

Now, let’s assume the farmer is fully over the threshold amount. In this case his Section 199A $40,000 deduction is limited to the lessor of 50% of wages (zero) or 25% of wages (zero) plus 2.5% of QP.  Let’s assume QP is $500,000.  In this case, his regular Section 199A deduction is limited to $10,000 reduced by zero since he paid no wages for a total Section 199A deduction of $20,000.

Now let’s see how paying $80,000 of wages affects these same calculations. In the first one, since 9% of $200,000 is less than 50% of wages ($40,000), the regular Section 199A deduction is now $22,000 (11% of $200,000).  Total Section 199A of $32,000.  In this case, the farmer lost $18,000 of Section 199A deduction.

However, in our second example, the farmer has no limit on the regular Section 199A deduction since he has plenty of wages. In this case, he will get the same $22,000 regular Section 199A deduction plus the $10,000 “DPAD” for a total of $32,000.  In this case, he gains $12,000.

As you can see, this can get very complicated. If the farmer is under the threshold, it is better to not have wages when selling to a cooperative.  When the farmer is fully over the threshold, it is likely better to have wages.  When they are in between the answer will be “It Depends”.