We just read an article from Bloomberg Tax that Congress appears to have a "fix" for the Section 199A cooperative deduction in place that will try to be enacted with the Budget CR that will be passed on or around next Friday March 23.
As most everyone is aware of by now, the new tax law provides a special 20% deduction of gross sales and payments received from a cooperative with the only limit being 100% of taxable income minus capital gains. Other income received from non-cooperatives is limited to the lessor of 20% of net business income or 20% of taxable income minus capital gains. Most everyone thought that this new law was simply for agricultural cooperatives, however, based on the actual wording of the Code, it applies to any cooperative. Therefore, you have many advisors trying to set up cooperatives for doctors, engineers, accountants, etc. to get the same 20% of gross income deduction. Many of these taxpayers would get no deduction under "regular" Section 199A since their income is too high; however, with the cooperative provision, there is no income limitation, etc. and would qualify for a full 20% of gross income deduction.
Congress became aware of this very quickly and tasked the privates and cooperatives to come up with a solution to this "problem". It appears that a solution may have been reached based upon the release by Bloomberg Tax. The Modification appears to make the following changes for producers:
- The 20% of gross sales to cooperatives deduction is eliminated;
- Farmers who sell to non-cooperatives continue to get the normal Section 199A deduction (e.g. lessor of 20% of net farm income or 20% of taxable income minus capital gains with certain limitations if income is over a threshold amount);
- Farmers who only sell to cooperatives appear to get a deduction equal to:
- A "DPAD" like deduction that flows through from the cooperative (if any) with only a taxable income limitation (not reduced by capital gains), plus
- 20% of net farm income minus the lessor of:
- 9% of net farm income, or
- 50% of wages paid
- With a limit still based on 20% of taxable income minus capital gains;
- Farmers who sell to both a cooperative and private would need to bifurcate the net farm income between both sources. The private income is subject to the regular Section 199A calculations and the cooperative income is subject to the rules listed above.
The goal of this change is to preserve the old 199 domestic production activities deduction (DPAD) for cooperatives and their patrons while providing some additional Section 199A deduction to farmers who sell to cooperatives.
Let's review some examples"
Farmer Jones only sells grain to the ABC cooperative. During 2018, he sells $5 million of grain to the cooperative and nets $500,000 on his farm income. He pays wages of $300,000. If he had not sold to a cooperative, his Section 199A deduction is simply $500,000 times 20% of $100,000. 50% of wages paid is $150,000, so he can deduct the full $100,000 Section 199A deduction (assume he has plenty of other taxable income). The ABC cooperative passes a proposed Section 199A (DPAD) deduction through to him equal to .5% of gross sales or $25,000. This is part 1 of his Section 199A deduction. Part 2 is to take the proposed Section 199A deduction of $100,000 and reduce it by the lessor of (1) net farm income of $500,000 times 9% or $45,000 or (2) 50% of wages or $150,000. Therefore, his part 2 Section 199A deduction is $55,000 ($100,000 minus $45,000). The bottom line Section 199A deduction for this farmer is $80,000 ($25,000 plus $55,000). If the cooperative had elected to pass none of the "DPAD" through to him, then his Section 199A deduction is limited to $55,000.
Now let's assume that Farmer Jones farm is a dairy and has net income from the dairy of zero and $500,000 of Section 1231 capital gains from selling raised breeding stock. Under current Section 199A rules, the dairy has a no Section 199A deduction since all of his taxable income is from capital gains. With this new proposal, the cooperative will pass through a proposed Section 199A DPAD closer to 4% of gross sales or $200,000 (part 1). Part 2 is the same calculation as above, however, since all of his income is capital gains, his $55,000 Section 199A part 2 deduction is limited to zero. Therefore, his total Section 199A deduction will be $200,000.
Let's go one step further. Let's assume that Farmer Jones taxable income is only $300,000 and no capital gains. His farm still nets $500,000. His Section 199A deduction is still $100,000 if he sells to a private, but his limit is 20% of taxable income, therefore, the net deduction is $60,000. Now, under the proposal, if he sells to a cooperative as in example 1, he gets the $25,000 DPAD from the cooperative, plus he gets the full $60,000 deduction just as if he sold to a private. That is due to no reduction in the Section 199A deduction since 50% of wages is zero. The only limit is the 20% of taxable income. In this case, his total Section 199A deduction would be $85,000 ($25,000 plus $60,000). The only limit on the $25,000 deduction is taxable income which is at least $240,000 ($300,000 minus the $60,000 Section 199A part 2 deduction).
As you can see, there will be some cases where a farmer who sells to a cooperative will be better off and there are cases where they will be worse off. Any compromise usually results in a situation where there are winners and losers on both sides and that appears to be the case here.
However, this still has to get through Congress and based on our reading of the tea leaves, the Democrats are in no hurry to help the Republicans get this passed. We will keep you posted.
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