Further Update on Section 199A

Published on: 15:42PM Mar 15, 2018

Based on our last two posts, we have gotten several comments.  Instead of responding to each of them individually, I am going to a post answers to each of their questions.  I will provide the original comment and then my answer.

Thanks for the clarification on the C-corp's. There is some confusion as to if S-corps will be included in on this new "DPAD" like deduction or not. It is my assumption that S-corps will be allowed to pass the deduction from Co-ops on to the shareholders personal level as they would in a partnership. Is that correct? It is my understanding that this 199A and will be new 199A is to apply to any taxpayer that is not structured as a C-corp and pays tax at the personal level.

The Section 199A deduction is available to all non-corporate taxpayers including estates and trusts (I will post on this later).  C corporations received their benefit from the reduction in the top tax rate of 35% down to 21%.  Yes, we know that most farmers only paid 15%, but most other corporate taxpayers paid closer to the 35% level (unless you were Google, Apple or most Fortune 500 companies).  Therefore, Congress enacted Section 199A to allow non-corporate taxpayers to receive a similar reduction in tax rates.  S corporations for purposes of Section 199A are essentially ignored.  All of the summary items of income and loss, W2 wages, and qualified property will be passed through to the shareholders on Schedule K-1.  If the proposed changes go through, any Section 199A "DPAD" deduction passed to the S corporation from the cooperative will also be reported on the Schedule K-1 and the shareholder will then determine their total Section 199A deduction.  A partnership and an S corporation will never have a Section 199A deduction, just the shareholders and the partners.

Will this fix be retroactive to 1/1/18 , time of passage, or some other specified date?

Yes, this fix will be retroactive to January 1, 2018.  However, if it does not pass by the end of March and there is a continued delay, that retroactive date may move forward.

Very confused by this new provision. Under the old rules in addition to the DPAD passed through from the coop a farmer could qualify for their own DPAD after bifurcation of coop/non-coop income if the operation paid out wages. From the looks of this, that same farmer will now be penalized by paying out wages. If the operation has no wages, the total 199A deduction would be the DPAD pass-through from the coop plus 20% of net income. If significant wages are paid out the 199A deduction would be the DPAD pass-through from the coop plus only 11% of net income. In addition, not all coop's have passed through the DPAD in past years and in fact those that do doubled up on the DPAD pass-through deduction for 2017 (due to its elimination) so there very well may be no DPAD available to pass-through in 2018. Does this interpretation seem correct to you Paul?

The comments made by reader are correct.  If the farmer has paid a lot of wages and has income related to cooperative sales, then it may be "penalized" with only an 11% Section 199A deduction assuming the cooperative does not pass out any Section 199A "DPAD" deduction.  However, under the old Section 199 rules, the farmer was entitled to no deduction on this bifurcated income due to the cooperative retaining the DPAD for its own use (now we know many farmers took the deduction anyway, but that is a separate item).  At least under the new proposal, the farmer is guaranteed at least an 11% deduction of net farm income (assuming enough wages paid if over the threshold amount) plus whatever Section 199A "DPAD" that is passed out.  Likely, this will force many more cooperatives to pass out the DPAD versus what may have happened under the old Section 199 law.

So C corporations will not qualify for any type of DPAD? What about flow through if they own shares in a partnership? Or flow through from the Cooperatives?

This question is very similar to the first question.  A C Corporation will not qualify for any Section 199A deduction, whether it is the Section 199A DPAD that is passed through from the cooperative or the 11%-20% of net corporation income.  There is NO Section 199A deduction to C Corporations. At a later point, we will work up the benefits and costs of being a C Corporation versus an S Corporation under the new law (waiting to see what final Section 199A actually is).  If the farmer is a Schedule F farmer, the cooperative Section 199A deduction will flow through directly to the farmer's personal tax return and be allowed as a deduction against 100% of taxable income, no matter the source (it can offset capital gains).  The farmer will then calculate his/her remaining Section 199A deduction equal to 20% of net farm income from non-cooperatives sales plus 11-20% of net farm income from cooperative sales subject to an overall limit on this separate deduction of 20% of (taxable income minus capital gains).

This provision is especially important for dairy farmers (we have blogged on this in the past).  Under the current Section 199A rules, the dairy could qualify for a 20% deduction of gross sales to a cooperative, however, this was then limited to taxable income minus capital gains.  Most dairies net taxable income is almost always capital gains from selling raised breeding stock.  Therefore, the new current Section 199A deduction did not give them much benefit.  Going back to the "Old" Section 199 DPAD rules now allows dairies to receive a new Section 199A DPAD deduction from their cooperative that will allow them to offset capital gain income from selling raised breeding stock.  Although the new DPAD may be closer to 3-4% of gross sales, it will likely have much higher value to a dairy than the current Section 199A deduction would.

Finally, if the proposal passes, the cooperative is able to pass out a new Section 199A DPAD deduction essentially equal to the lessor of 9% of its taxable income or 50% of wages paid by the cooperative.  In almost all cases it is equal to 50% of wages paid.  Therefore, the higher the wages paid by the cooperative (dairy, sugar beet, apple warehouses, grape juice processing, etc.), the greater the deduction to the farmer.  The lower the wages (most grain marketing cooperatives), then a smaller Section 199A DPAD deduction will be passed out.

As we said in our previous post on this, there will be winners and losers if this proposal passes.  We will keep you posted.