The "fix" for the "grain glitch" that we have previously posted on several times is now part of the budget bill that should be passed by the end of this week. Since we are now fairly certain as to what the final 199A law will be, I thought it would be good to go over the winners and losers of 199A (in its final form).
First, for all non-corporate farmers, there are no losers compared to the old law in effect before 2018. In almost all cases, your deduction under Section 199A will be greater than any deduction that you got under Section 199 DPAD. At a minimum, you will get an 11% deduction for dealing with a cooperative. This is the worst case and it is still larger than the old 9% which was then limited to 50% of wages paid. Under the old law, if you had no wages paid, you got no deduction (other than any DPAD from a cooperative). Under the new law, you get a minimum of 11% (up to the threshold amount).
Now you will likely notice I started the last paragraph with non-corporate farmers. Therefore, it must mean that the losers may include C corporation farmers. The answer is yes and no. C Corporations will not be entitled to any Section 199A deduction. However, in return, these entities saw their top tax rate drop from 35% to a flat 21%. Therefore, they already received a 40% tax reduction. The only reason for giving any Section 199A benefit to non-corporate taxpayers was to level the playing field with this lower corporate tax rate. Congress was not interested in maintaining the Section 199 deduction for any taxpayers. Calling the deduction 199A simply added confusion for taxpayers in assuming it had something to do with old Section 199. We do know that many farm corporations will see a 40% tax increase from 15% to 21% and not receive any Section 199A deduction. These taxpayers are the biggest loser.
I will try to rank winners from biggest winner to smallest winner under final Section 199A. I know I may miss some and some may argue with my analysis, but here is my ranking:
- Dairy farmers - Under old Section 199, they could receive a DPAD from the cooperative equal up to about 4% of gross sales and be able to offset this against 100% of their taxable income. Under Section 199A as first passed, they could not offset any of this deduction against capital gains from the sale of raised breeding stock. Final Section 199A allows them to deduct fully the DPAD from the cooperative against all taxable income plus receive an additional deduction up to 20% of net farm income (likely 11%) to offset 20% of taxable income minus capital gains. As an example - Dairy farmer John sells $10 million of milk to his cooperative and nets $100,000 on his Schedule F and has $500,000 of capital gains from selling raised breeding stock. Under the old law, he received a $400,000 DPAD from his cooperative which reduced his net taxable income to $200,000 of capital gains. Under original Section 199A he could only offset Schedule F income and would owe tax on $500,000 of capital gains. Under final Section 199A, his $400,000 offsets any of the taxable income and is allowed an additional small $11,000 Section 199A deduction (Schedule F $100,000 income times 11%). Other farmers who belong to cooperatives with a large amount of labor will see deductions similar to dairy farmers (sugar beet farmers, orchardists, etc.)
- Grain farmers who only sell to cooperatives with taxable income under the threshold amount and pay no wages subject to payroll taxes - Under the old law, the farmer's only deduction in this situation was the DPAD they received from the cooperative, if any. Under final Section 199A, the farmer will receive the same DPAD plus they will qualify for a 20% of net business income Section 199A deduction. As an example, assume married Farmer Mary has taxable income of $300,000 from her farm. She sells $2.5 million of grain to her local cooperative which sends her a DPAD of $20,000. Her final Section 199A deduction is $20,000 from the cooperative plus $60,000 on her Schedule F for a total deduction of $80,000. Under old Section 199, their deduction was limited to $20,000.
- Grain farmers who do not sell to cooperatives and have sufficient wages - In this situation, under old Section 199, their tax deduction was simply 9% of net farm income. Under Section 199A, their deduction will be 20% of net farm income. If taxable income is less than farm income, then the deduction is limited to 20% of that number minus capital gains. As an example, assume Farmer Tom nets $500,000 on his farm operation. Under old Section 199, his deduction was $45,000 (limited to 100% of taxable income). Under Section 199A, his deduction is $100,000 limited to 20% of (taxable income minus capital gains).
- Grain farmers who only sell to cooperatives and have a fair amount of wages paid - This situation is similar to #2, however, instead of receiving a deduction equal to 20% of net farm income, the deduction drops to 11%. As an example - assume our married Farmer Mary pays $100,000 wages. Instead of an $80,000 deduction, it is now reduced to $53,000 (11% of $300,000 plus $20,000). If she did not sell to a cooperative, then her deduction would be $60,000. As you can see, there are situations for grain farmers where it may be better to sell to a cooperative or may not be better.
- Dairy farmers who sell to a cooperative and are incorporated - As previously mentioned, dairy farmers who farm as a C corporation (or almost any other farmer who deals with a cooperative with high wages) will not like the new law. Under the old law, the corporation could deduct the DPAD from the cooperative. Under the new law, no deduction is allowed. As an example, let's take our first example and assume it is a C corporation. Under the old law, the corporation would pay tax on $200,000 of income (roughly $60,000) since the DPAD could offset all taxable income. Under the new law, no deduction is allowed and the corporation pays $126,000 in tax. Yes, the overall tax rate dropped from about 30% to 21%, but more income is subject to tax. This farmer will now consider switching to an S corporation.
Finally, one other non-farm loser may start to become apparent. Under old Section 199, many cooperatives retained 100% of the DPAD to help offset their taxable income. Because many smaller farmers could not take a Section 199 deduction since they paid no wages, this may have been a win for the cooperative. Most taxpayers assume that cooperatives do not pay taxes. The correct answer is that most of them may be subject to income taxes at the corporate tax rate (dropped from 35% to 21%) on some amount of taxable income. The old DPAD helped reduce or eliminate this income tax. However, with new Section 199A having a possible reduction of the Section 199A deduction for farmers dealing with cooperatives, more cooperatives may be directed by their board of directors to pass out all or most of the DPAD under the new law.
This is a review of the winners and losers. Your situation maybe very similar to one of these, or it may lie somewhere in the middle. We are still waiting for IRS guidance on many issues regarding Section 199A so it is difficult even now to say "what is best". We will keep you posted.