By: Barry Ward, Director, Ohio State University Income Tax Schools, Leader, Production Business Management
Upon passage and signing of the Tax Cuts Jobs Act in December 2017, Cooperatives suddenly had a decided advantage in buying over “independent” buyers of ag commodities. The new tax law had somewhat inadvertently included a “grain glitch” (which would have affected more than grain sales) that had effectively allowed for a 20% deduction on gross sales which conferred a decided advantage over sales to other non-Cooperatives. These sales to non-Cooperatives would only be allowed the QBID deduction as discussed previously in this article which effectively a 20% deduction on net income from those sales. With much hand wringing and angst in the ag sector, congress finally got around to passing a “fix” to this “glitch.”
The “Consolidated Appropriations Act 2018” signed on March 23, 2018 “fixed” this inequity and but added more complexity to the reporting of sales to cooperatives. The 20% deduction calculated based upon their gross sales was eliminated and replaced with a hybrid Section 199A deduction. For those with sales to both cooperatives and non-cooperatives it will likely add some additional paperwork burden.
To determine the IRC Section 199A Deduction for sales to cooperatives, patrons first calculate the 20% 199A QBI deduction that would apply if they had sold the commodity to a non-cooperative. Second, the patron must then subtract from that initial 199A deduction amount whichever of the following is smaller:
- 9% of net income attributable to cooperative sale(s) OR
- 50% of W-2 wages paid to raise products sold to cooperatives.
Lastly, the allocable QBID deduction from the cooperative (up to 9%).
Sales to coops may result in a net QBI Deduction. The net deduction may be greater than 20% if the farmer taxpayer pays no W2 wages and the cooperative passes through all or a large portion of the allocable QBI to the patron. Or the net deduction may be equal to 20% if the farmer taxpayer pays enough W2 wages to fully limit their coop sales QBI deduction to 11% and the coop passes through all allocable QBI. Or the net deduction may be less than 20% if farmer taxpayer pays enough W2 wages to fully limit their coop sales QBI to 11% and the coop passes through less than the allocable QBI.
The following examples illustrate how patrons calculate the QBI deduction at the individual level.
QBI deduction for co-op patron’s sales — No wages paid
Pat Patron, a single taxpayer, is a member patron of Big Co-op. In 2018, he sold all his grain through Big Co-op. Big Co-op paid Pat a $230,000 per-unit retain paid in money (PURPIM) and a $20,000 end-of-year patronage dividend. Thus, in 2018, Pat received $250,000 ($230,000 + $20,000) from Big Co-op for his grain sales. Pat also had $200,000 in expenses, which did not include any W-2 wages. Pat had no capital gain income in 2018, but he received wages from an outside job. His taxable income was $75,000.
Pat’s 2018 QBI is $50,000 ($250,000 − $200,000). Pat calculates a $10,000 (20% × $50,000) tentative QBI deduction. Pat’s taxable income is below the $157,500 threshold for single taxpayers, so his QBI deduction is not limited by the W-2 wages limitation. Because all of Pat’s tentative QBI deduction is attributable to qualified payments he received from Big Co-op, Pat must reduce his QBI deduction by the lesser of
- $4,500 (9% × $50,000), or
- $0 (50% of $0 W-2 wages attributable to Pat’s co-op payments)
Because Pat paid no wages for his grain business, he does not have to reduce his QBI deduction. Pat claims the $10,000 QBI deduction.
The facts are the same as in Example 1, except that in 2018, Big Co-op also allocated a $2,500 deduction to Pat for his share of the co-op’s QPAI. The deduction does not exceed Pat’s taxable income after subtracting his QBI deduction ($75,000 − $10,000 = $65,000). Pat’s QBI deduction is $12,500 ($10,000 + $2,500).
QBI deduction for co-op patron’s sales —With wages
The facts are the same as in Example 1, except that $25,000 of Pat’s $200,000 in expenses were W-2 wages that he paid to an employee. Pat’s tentative QBI deduction is still $10,000 (20% × $50,000). However, he must reduce his QBI deduction by the lesser of the following:
- $4,500 (9% × $50,000) or
- $12,500 (50% × $25,000) Pat has a $5,500 QBI deduction ($10,000 − $4,500).
Transition rules for sales to cooperatives
Also as part of the “grain glitch” fix in March of this year, a transition rule was included in the Code regarding qualified payments made by a cooperative with a year that began in 2017 and ended in 2018 (Fiscal Year Cooperative). This provision indicates that any payments received by a patron (farmer) during 2018 that is also included in the cooperatives taxable year ending in 2018 is not allowed to be used in calculating Section 199A.
The farmer will simply receive the DPAD passed through by the cooperative for that year (if any) and be allowed to only deduct that on their tax return. None of the qualified payments made to the farmer during the cooperatives fiscal year ending in 2018 are allowed for QBI. In other words, the farmer selling products to a cooperative with a fiscal year ending sometime in 2018 prior to Dec. 31, 2018 will not be able to claim the sales prior to the fiscal year end date as QBI for purposes of the QBI deduction. Not a great deal for farmers with sales to cooperatives prior to the cooperative’s fiscal year end date.
Many cooperatives issued a Section 199 DPAD deduction in Dec. of 2017. This means that these farmers got a deduction in 2017 when rates were higher, however, due to the transition provision, these farmers will perhaps not qualify for much, if any Section 199A deduction in 2018 AND not receive any DPAD from the cooperative since it was “pushed” out in 2017. This is what we may call a “double whammy.” The reason it may be so drastic is that many grain farmers receive most of the proceeds from their grain sales in the first few months of the year and then simply have little or no sales the remaining part of the year.
The bottom line is that farmers who sell to a cooperative may not get the deduction they were planning on this year due to the transition rule.
This also means that the cooperative will need to report to the patron the amount of qualified payments made to the patron in 2018 that was included in the cooperative’s Section 199 computation from Jan. 1, 2018 to the last day of the cooperative’s fiscal year ending in 2018.