By: Eric M. Bennett, CPA, Director and John Gricius, CPA, Manager
The Tax Cuts and Jobs Act (TCJA) changed the rules related to the previous Section 199 deduction, known as the Domestic Production Activity Deduction (DPAD). It did not just change the code section reference from 199 to 199A. When the TCJA originally passed, Congress inadvertently gave a temporary large advantage to farmers who sold their grain to cooperatives, formerly known as the “Grain Glitch.” The glitch created an unfair advantage in grain marketing as it greatly incentivized farmers to sell only to cooperatives. Congress updated Section 199A and fixed the “Grain Glitch” by requiring farmers to calculate their 20% 199A deduction on all farm net income, including net income from cooperatives, the latter of which was the main part of the fix.
Farmer Section 199A
Under the modified rules, a farmer would calculate the 199A deduction like any other taxpayer on business or pass-through income. However, farmers must separate their taxable income between income earned on cooperative sales and income earned on sales to other entities. This is necessary under the new law due to the ability for cooperatives to pass out 199A deductions to patron members. After the total deduction is calculated, the farmer would potentially have to reduce their deduction by the lesser of 9% of cooperative qualified business income or 50% of wages allocated to the cooperative qualified business income. If a farmer had no wages, there would be no reduction of the deduction. Otherwise, the maximum reduction to the 20% deduction would only be 9% of qualified cooperative taxable income. At the very least, the patron would get an 11% deduction of cooperative qualified taxable income and 20% deduction on all non-cooperative taxable income as there is no reduction of 199A for non-cooperative taxable income.
The new Section 199A law unfortunately prompted the IRS to re-write the rules for new cooperative DPAD. Despite opposition from Cooperative advocacy groups, final regulations for new DPAD 199A(g) were released mid-January of 2021. With these revised regulations, the IRS has made a number of changes to the well-established former law, including the decision to only allow the member based DPAD deduction starting for years beginning after January 19, 2021. The intention of the new law, per the advocacy groups, was to have 199A(g) mirror the old 199, yet these regulations changed many more aspects of the 199 deduction, and that is not what was believed to be Congressional intent.
Before final regulations were published, there were proposed regulations in place that were substantially similar, but not as enforceable as the final regulations. Therefore, pre-final regulations, most cooperatives followed old law and allocated the DPAD deduction between member and non-member sources, further reducing total taxable income.
199A(g) for Cooperatives
The DPAD deduction for Cooperatives previously, and currently, is limited to the lower 9% of qualified production activities income (QPAI), 9% of taxable income, or 50% of wages. Cooperatives before and after TCJA and pre-new regulations, essentially took qualified revenue, less qualified costs of goods sold, less allocated other expenses to come up with QPAI. Then 199A(g) limitation was generally 9% of QPAI.
Note: There were several adjustments to QPAI if the cooperative purchased grain from members, but that is a much longer explanation, beyond the scope of this article, suitable for your qualified Blue & Co., LLC tax advisor.
What follows is a very simplified example of a mostly “supply” cooperative:
As mentioned, with the final regulations, cooperatives are not allowed to use a non-member DPAD deduction. As you can see in the above example, the cooperative will lose $36,000 of the DPAD deduction, which is $7,560 in federal tax ($36,000 x 21%). The elimination of the non-member deduction could have some significant tax implications, especially if the cooperatives have high non-member business activity.
Therefore, as demonstrated in this article, the farmer/patron 199A and cooperative 199A(g) deduction calculations are very complex and come with several caveats. We would be happy to explain how this deduction could affect your tax filings. Please contact your local Blue & Co. advisor if you have any questions.
Download the Ag Co-Op Year in Review Guide
Blue & Co., LLC annually accumulates certain operational and financial data from our agricultural cooperative client base as part of preparing peer analyses which are presented to management and boards.
Complete the form below to download the report which is a summary of selected information from Blue’s ag cooperative client base from 2017-2021, broken down by area of interest.