By Ashley Kieke
When President Donald Trump first signed tax reform into law it included an extremely beneficial tax provision for farmers selling commodities to cooperatives. With the signing of new legislation on March 23, we now have a new version of Section 199A, which in most cases levels the playing field between cooperatives and non-cooperatives.
As expected, the change is retroactive beginning Jan. 1, 2018, and leaves us with a lot of complexities, some of which we are still working through. Overall, this may be one of the most complicated areas of the new tax law, and careful review with your tax professional is recommended as there are a lot of “what-ifs” and “it depends” based on each farmer’s individual situation.
This law was created with the intent to provide sole proprietors and flow-through entities a tax benefit. Legislators felt that C corporations already received a tax break by a reduction in the top corporate tax rate down to 21%, therefore there is no Section 199A deduction available to C corporations.
With the recent fix to this law, we are now looking at a three-step process for calculating the deduction available to farmers.
1. Calculate 20% of qualified business income (for purposes of this article we will simplify this to be 20 percent of net farm income).
2. Subtract from the result of Step 1 the lessor of 9% of net income attributable to cooperative sales or 505 of W-2 wages paid to earn income from the cooperative.
3. Include with your deduction any deduction passed through to you from the cooperative. The law originally provided that there would no longer be a deduction passed through from cooperatives to their patrons, but this was changed as part of the overall “fix” to the new law.
A taxpayer’s ultimate deduction will be limited to 20% of taxable income less capital gains (with the exception of the deduction passed through from the cooperatives, this can be utilized to offset capital gain income). Note that there are additional limitations to the deduction if taxable income exceeds certain limits. If your taxable income exceeds $315,000 if married filing jointly or $157,500 if single, reach out to your tax professional for more information on how this impacts your deduction.
Assume dairy farmer John files his tax return married filing jointly with $1,200,000 of milk sales to a cooperative and has net farm income of $150,000 and paid wages of $100,000. Under the old rules, they would have received a Domestic Production Activities Deduction (DPAD) from the cooperative. The DPAD received likely would have been around $12,000, but this amount may vary depending on the cooperative. Under the new Section 199A, the deduction is calculated as $30,000 (150,000 times 20%) less 13,500 (the lessor of 150,000 times 9%, or 100,000 times 50%) plus anything received from the cooperative.
Assume grain farmer Beth files her tax return married filing jointly with $3,000,000 of grain sold to a cooperative and has net farm income of $250,000 and paid $0 of wages. Under the old rules, she received a DPAD from the cooperative. The DPAD received likely would have been around $30,000, but as mentioned, this amount may vary depending on the cooperative the farmer sells to. Under the new section 199A, her deduction is calculated as $50,000 ($250,000 times 20%). In this case, there is no reduction to her Section 199A deduction because there are not wages paid. Her overall deduction will be increased by anything received from the cooperative.
Now let’s assume grain farmer Kyle has the same facts as Grain Farmer Beth but pays $80,000 in wages. His deduction would be calculated as $50,000 ($250,000 times 20%) less 22,500 (the lessor of $250,000 times 9%, or 80,000 times 50%) plus anything received from the cooperative.
Now assume the same facts for grain farmer JoAnn, but she decides not to sell any of her grain to a cooperative. Her deduction is calculated as $50,000 ($250,000 times 20%).
Whether wages are paid can impact whether there is a benefit for selling to a cooperative or a non-cooperative.
Still some unknowns
We are still in the very early stages of understanding this new tax law and are waiting on additional guidance from the IRS to understand how this deduction will impact different taxpayers. At this point, it is important to understand this calculation will change depending on your facts and circumstances, such as, "Do you pay wages?" and, "Are you selling your commodities to a cooperative?" Another unknown is what amount the cooperatives will pass through to their patrons as a deduction, as this deduction will likely range in size.
If you are looking for guidance on how this deduction will impact your 2018 tax return, tax specialist to set up a tax planning meeting and they can help you calculate an estimate. This may be especially important if you are on state health insurance exchange and are receiving subsidies based on your 2017 taxable income.
Kieke is a senior tax specialist with AgCountry Farm Credit Services.