Qualified Business Income Deduction for Sales to Cooperatives – Proposed Regulations

by: Barry Ward, Leader, Production Business Management
Director, OSU Income Tax Schools

Soon after the Tax Cuts and Jobs Act became law in December of 2017 it became evident that cooperatives had been granted a significant advantage under the new tax law. Sales to cooperatives would be allowed a Qualified Business Income Deduction (QBID) of 20% of gross income and not of net income. Sales to businesses other than cooperatives would be eligible only for the QBID of net income which was a significant disadvantage. Suddenly cooperatives had an advantage that non-cooperative businesses couldn’t match and most of the farm sector scrambled to position themselves to take advantage of this tax advantage. Some farmers directed larger portions of their sales or prospective sales toward cooperatives. Non-cooperative businesses lobbied for a change to this piece of the new tax law while looking for ways to add a cooperative model to their own businesses to stay competitive.

Congress passed the Consolidated Appropriations Act of 2018 in March of 2018 which eliminated this advantage to cooperatives and replaced it with a new hybrid QBID for sales to cooperatives which offered more tax neutrality between sales to cooperatives and non-cooperatives. While this new legislation leveled the playing field between cooperatives and non-cooperatives, it left many questions unanswered; chief among them was how taxpayers should allocate expenses between sales to cooperatives and non-cooperatives.

One area that was clarified for calculating the QBID for all businesses including cooperatives was how certain deductions should be handled with respect to the Qualified Business Income Deduction (QBID).

For purposes of the QBID (IRC §199A), deductions such as the deductible portion of the tax on self-employment income under § 164(f), the self-employed health insurance deduction under § 162(l), and the deduction for contributions to qualified retirement plans under § 404 are considered attributable to a trade or business (including farm businesses) to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis.

Under the final regulations, expenses for half the self-employment (SE) tax, self-employed health insurance, and pension contributions must be subtracted from preliminary QBI figure, before any cooperative reductions are made (if applicable).

While final regulations on the new QBID were published on Jan. 18, 2019, there were still many questions left unanswered as to how the deduction would be handled in relation to cooperatives. As the QBID is calculated differently between the income from sales to cooperatives and non-cooperatives, taxpayers and tax practitioners were left with uncertainty.

A simplified explanation of the steps used to calculate the QBID under Internal Revenue Code (IRC) §199A for income attributable to sales to cooperatives is listed here:

Step 1: First, patrons calculate the 20 percent §199A QBID that would apply if they had sold the commodity to a non-cooperative.

Step 2: The patron must then subtract from that initial §199A deduction amount whichever of the following is smaller:

  • 9 percent of the QBI allocable to cooperative sale(s) OR
  • 50 percent of W-2 wages paid allocable to income from sales to cooperatives

Step 3: Add the “Domestic Production Activities Deduction (DPAD)-like” deduction (if any) passed through to them by the cooperative pursuant to IRC §199A(g)(2)(A). The determination of the amount of this new “DPAD-like” deduction will generally range from 0 to 9 percent of the cooperative’s qualified production activities income (QPAI) attributable to that patron’s sales.

Parts of the new tax law do offer some simplification. Calculating the QBID isn’t necessarily one of those parts. The result of all of these calculations is that income attributable to sales to cooperatives may result in an effective net QBID that is:

  • Possibly greater than 20% if the farmer taxpayer pays no or few W2 wages and coop passes through all or a large portion of the allocable “DPAD-like” deduction
  • Approximately equal to 20% if the farmer taxpayer pays enough W2 wages to fully limit their coop sales QBID to 11% and the coop passes through all allocable “DPAD-like” deduction
  • Possibly less than 20% if farmer taxpayer pays enough W2 wages to fully limit their coop sales QBID to 11% and the coop passes through less than the allocable “DPAD-like” deduction

On June 18th, the IRS released proposed regulations under IRC §199A on the patron deduction and the IRC §199A calculations for cooperatives. The proposed regulations provide that when a taxpayer receives both qualified payments from cooperatives and other income from non-cooperatives, the taxpayer must allocate deductions using a “reasonable method based on all the facts and circumstances.” Different reasonable methods may be used for the different items and related deductions. The chosen reasonable method, however, must be consistently applied from one tax year to another and must clearly reflect the income and expenses of the business.

So what “reasonable methods” might be accepted by the IRS? The final regulations (when they are provided) may give us further guidance or we may be left to choose some “reasonable” method in allocating expenses between the two types of income. Acceptable methods may include allocating expenses on a prorated basis by bushel/cwt or by gross sales attributable to cooperatives and non-cooperatives. Producers may also consider tracing costs on a per field basis and tracking sales of those bushels/cwt to either a cooperative or non-cooperative.

Included in the proposed regulations released in June was a set of rules for “safe harbor”. A taxpayer with taxable income under the QBID threshold ($157,500 Single Filer / $315,000 Joint Filer) may ratably apportion business expenses based on the amount of payments from sales to cooperative and non-cooperatives as they relate to total gross receipts. In other words, expenses may be allocated between cooperative and non-cooperative income based on the respective proportions of gross sales that fall to cooperatives and non-cooperatives.

Some questions that haven’t been answered clearly is how certain other income should be allocated between income from cooperatives and non-cooperatives. Tax reform now requires farmers to report gain on traded-in farm equipment. In many cases, farm income will be negative and all of the income for the business will be from trading-in farm equipment. The question is how do we allocate this income (IRC §1245 Gain)? Some commentators contend that none of these gains should be allocated to cooperative income which would eliminate the issue, however, the depreciation deduction taken on the equipment was likely allocated to cooperative income, thus reducing the effect of the 9% of AGI patron reduction. This would suggest that these gains may have to be allocated between cooperative and non-cooperative income.

How should government payments be allocated? If a farmer sells all of their commodities to a cooperative and receive a government payment (i.e. ARC or PLC), should that be treated as cooperative income or not. Hopefully, the final regulations will provide some further clarity on these issues.

The information in this article is the opinion of the author and is intended for educational purposes only. You are encouraged to consult professional tax or legal advice in regards to your facts and circumstances regarding the application of the general tax principles cited in this article.

 

 

Tax Planning in an Unusual Year – Prevented Planting Indemnity Payments, Market Facilitation Payments and Cost-Share Payments

by: Barry Ward, Leader, Production Business Management & Director, OSU Income Tax Schools

Prevented Planting Crop Insurance Indemnity Payments

With unprecedented amounts of prevented planting insurance claims this year in Ohio and other parts of the Midwest, many producers will be considering different tax management strategies in dealing with this unusual income stream. In a normal year, producers have flexibility in how they generate and report income. In a year such as this when they will have a large amount of income from insurance indemnity payments the flexibility is greatly reduced. In a normal year a producer may sell a part of grain produced in the year of production and store the remainder until the following year to potentially take advantage of higher prices and/or stronger basis. For example, a producer harvests 200,000 bushels of corn in 2019, sells 100,000 bushels this year and the remainder in 2020. As most producers use the cash method of accounting and file taxes as a cash based filer, the production sold in the following year is reported as income in that year and not in the year of production. This allows for flexibility when dealing with the ups and downs of farm revenue.

Generally, crop insurance proceeds should be included in gross income in the year the payments are received, however Internal Revenue Code Section (IRC §) 451(f) provides a special provision that allows insurance proceeds to be deferred if they are received as a result of “destruction or damage to crops.”

As prevented planting insurance proceeds qualify under this definition, they can qualify for a 1 year deferral for inclusion in taxable income. These proceeds can qualify if the producer meets the following criteria:

  1. Taxpayer uses the cash method of accounting.
  2. Taxpayer receives the crop insurance proceeds in the same tax year the crops are damaged.
  3. Taxpayer shows that under their normal business practice they would have included income from the damaged crops in any tax year following the year the damage occurred.

The third criteria is the sometimes the problem. Most can meet the criteria, although if producers want reasonable audit protection, they should have records showing the normal practice of deferring sales of grain produced and harvested in year 1 subsequently stored and sold in the following year. To safely “show that under their normal business practice they would have included income from the damaged crops in any tax year following the year the damage occurred” the taxpayer should follow IRS Revenue Ruling 75-145 that requires that he or she would have reported more than 50 percent of the income from the damaged or destroyed crops in the year following the loss. A reasonable interpretation in meeting the 50% test is that a farmer may aggregate the historical sales for crops receiving insurance proceeds but tax practitioners differ on the interpretation of how this test may be met.

One big problem with these crop insurance proceeds is that a producer can’t divide it between years. It is either claimed in the year the damage occurred and the crop insurance proceeds were received or it is all deferred until the following year. The election to defer recognition of crop insurance proceeds that qualify is an all or nothing election for each trade or business IRS Revenue Ruling 74-145, 1971-1.

Tax planning options for producers depend a great deal on past income and future income prospects. Producers that have lower taxable income in the last 3 years (or tax brackets that weren’t completely filled) may want to consider claiming the prevented planting insurance proceeds this year and using Income Averaging to spread some of this year’s income into the prior 3 years. Producers that have had high income in the past 3 years and will experience high net income in 2019 may consider deferring these insurance proceeds to 2020 if they feel that this year may have lower farm net income.

Market Facilitation Payments

When the next round(s) of Market Facilitation Payments (MFPs) are issued, they will be treated the same as the previous rounds for income tax purposes. These payments must be taken as taxable income in the year they are received. As these payments are intended to replace income due to low prices stemming from trade disputes, these payments should be included in gross income in the year received. As these payments constitute earnings from the farmers’ trade or business they are subject to federal income tax and self-employment tax. Producers will almost certainly not have the option to defer these taxes until next year. Some producers waited until early 2019 to report production from 2018 and therefore will report this income from the first round of Market Facilitation Payments as taxable income in 2019.

Producers will likely not have the option of delaying their reporting and subsequent MFP payments due to the fact they are contingent upon planted acreage reporting of eligible crops and not yield reporting as the first round of MFP payments were.

Cost Share Payments

Increased prevented planting acres this year have many producers considering cover crops to better manage weeds and erosion and possibly qualify for a reduced MFP. There is also the possibility that producers will be eligible for cost-share payments via the Natural Resources Conservation Service for planting cover crops. Producers should be aware that these cost-share payments will be included on Form 1099-G that they will receive and the cost-share payments will need to be included as income.

You are advised to consult a tax professional for clarification of these issues as they relate to your circumstances.

New Podcast Episodes

by: Amanda Douridas, OSU Extension Educator

The Agronomy and Farm Management Podcast has been releasing new episodes every other week since May 2018 and is set to release its 29th episode next Wednesday. To make it easier for listeners to find past episodes, the podcast has a new landing page at http://go.osu.edu/AFM.

Here you will find a listing of all past episodes, descriptions of what we talked about and links to additional resources. We cover a wide range of topics for corn, soybean and small grain farmers on agronomic and farm management topics. Episodes include legal topics such as leases, LEBOR, and hemp; timely seasonal topics like disease, insects and weather; and operational improving strategies related to nutrient management, precision agriculture and grain marketing.

Stay up to date on the latest episodes by following us on Twitter and Facebook (@AFMPodcast) and adding us to your favorites in Apple Podcasts or Stitcher. Give us a good rating and review if you like the podcast! If there is a listening platform you would like us to broadcast on or you have a topic suggestion, reach out on social media or by email at Douridas.9@osu.edu.

 

Should I Continue Farming?

by:  Chris Zoller, Extension Educator, ANR- Tuscarawas County

 It’s no secret that all of agriculture is suffering from years of low commodity prices and rising input costs. The economic struggles have affected you financially and physically. You’ve looked at the numbers, met with advisors, and talked to family.   The thought of selling part or your entire farm brings with it added worry and concern. What can you do?

Find someone you trust and with whom you feel comfortable discussing your situation. This person may not have many answers to your questions, but they can listen to your frustrations and worries. They may be able to help you sort through the confusion and develop a course of action. Think of your situation as a picture – a set of eyes looking at the picture from the outside may see things you can’t because you are caught up in the picture.

Understand that you are not alone. Nearly every farm and farm family is in a similar situation. Don’t live in the past or dwell on what could or should have been done. Take control of the situation and develop a plan for managing the things you are able to control.

Assessment

Evaluate your financial position by meeting with your lender to discuss options for restructuring debt. Can you extend the repayment terms to provide more cash flow? Contact your Extension Educator about completing a FINPACK analysis (https://farmprofitability.osu.edu/).

What are your Specific, Measurable, Attainable, Rewarding, and Timed (SMART) goals? How are your goals similar and different from those of family and/or business partners?

Develop a list of your education, experiences, and skills. How can you use these in another career? What career opportunities fit you best?

Evaluation

If you come to the decision that selling all or part of your farm is the best option, there are several items to address. Begin with a balance sheet and other financial information to understand your present financial situation. Doing so will help you decide how much money (and approximate number of assets) you must sell. You may want to meet with an appraiser, auctioneer, or real estate professional for help determining the expected value of assets.

Professionals

Your attorney can answer questions and advise you about legal considerations related to a sale. An accountant will help minimize your tax liability and give an estimate of what you may expect to pay in taxes.

Help is Available

There are people and agencies/organizations that can help with the transition and the emotions that come with the sale. Clergy, licensed counselors, and medical professionals can help you cope. Other sources of help include:

Ohio State University Extension (extension.osu.edu)

National Suicide Prevention (1-800-273-8255)

National Alliance for Mental Illness (1-800-950-6264)

Ohio Workforce Training (ohio.gov/working/training)

Ohio Job & Family Services, Office of Workforce Development (jfs.ohio.gov/owd)

Additional Information

Coming to the decision to sell all or a part of your farm is not an easy decision. Find someone with good listening skills. Talk to professionals, reach out for help, get answers, and make the best possible decisions. More information about this subject is available at https://ohioline.osu.edu/factsheet/anr-71.

 

REMINDER- Registration will close soon…Come Join Us for the…Small Farm Conference & Trade Show

The two day conference will be held on Friday, March 29th and Saturday, March 30th at the OSU South Centers in Piketon, Ohio.

The conference is designed for small farm owners wanting to learn more about how to make their farms work better for them. Many topics will be offered to help landowners expand their operations. Land owners can attend workshops and seminars taught by Extension professionals and industry leaders on a wide variety of agricultural enterprises.  Attendees will also get to meet various vendors at the trade show.  The trade show will be open part of the day on Friday, and all day Saturday.

Attached is the brochure that includes a mail-in registration, the agenda with session descriptions, and the registration letter for vendors.

Please see the flyer below for additional information.

For full details, please go to go.osu.edu/OSUFARMConference2019.

Source:  IR-2019-28

WASHINGTON — The Internal Revenue Service will waive the estimated tax penalty for any qualifying farmer or fisherman who files his or her 2018 federal income tax return and pays any tax due by Monday, April 15, 2019. The deadline is Wednesday, April 17, 2019, for taxpayers residing in Maine or Massachusetts.

The IRS is providing this relief because, due to certain rule changes, many farmers and fishermen may have difficulty accurately determining their tax liability by the March 1 deadline that usually applies to them. For tax year 2018, an individual who received at least two-thirds of his or her total gross income from farming or fishing during either 2017 or 2018 qualifies as a farmer or fisherman.

To be eligible for the waiver, qualifying taxpayers must attach Form 2210-F, available on IRS.gov, to their 2018 income tax return. This form can be submitted either electronically or on paper. The taxpayer’s name and identifying number, usually a Social Security number, must be entered at the top of the form. The waiver box—Part I, Box A—should be checked. The rest of the form should be left blank.

Further details can be found in Notice 2019-17, posted today on IRS.gov.

 

 

Sales to Cooperatives Under the New Tax Law

Barry Ward, Director, OSU 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-percent 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 percent 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:

  1. Nine (9) percent of net income attributable to cooperative sale(s) OR
  2. Fifty (50) percent 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

  1. $4,500 (9% × $50,000), or
  2. $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.

Pass-Through 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:

  1. $4,500 (9% × $50,000) or
  2. $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 December 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 December 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 January 1, 2018 to the last day of the cooperative’s fiscal year ending in 2018.

The New Tax Law and the New Business “Qualified Business Income” Deduction

by: Barry Ward, Director, OSU Income Tax Schools & Leader, Production Business Management

The new tax law known as the Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017 and will affect income tax returns for all of us for 2018 (to be filed in the next few months). The headline pieces of the new tax law include new tax brackets, higher standard deductions, elimination of personal exemptions and a new corporate flat tax rate of 21%. This will amount to lower total federal income tax for the large majority of taxpayers and C-corporations. Parts of the new tax law will make tax preparation simpler while parts will add complexity to the process.

With the new lower tax rate for corporations (specifically C-corporations) of 21% (a flat 21% rate) this replaces the old graduated tax brackets for C-corporations that started at 15% and topped out at 35%. The new lower tax rate for C-corporations may have created a decidedly uneven playing field if the new tax law hadn’t included a new deduction for all other businesses. This new Qualified Business Income Deduction (QBID) (sometimes referred to as the Pass-Through Deduction) is a 20% deduction of a businesses’ Qualified Business Income (QBI). Without this, businesses across the U.S. would have been strongly considering a change to a C-Corp structure for income tax purposes. With this QBID, the playing field between the different tax entities is mostly re-leveled. There may be inequalities that show up with the new tax law as it relates to business entity selection but it may take some time for these inequalities to reveal themselves.

The new Qualified Business Income Deduction is laid out in Section 199A of the Internal Revenue Code (IRC). This new deduction has also been referred to as the 199A Deduction, the §199A Deduction for Pass-through Entities, the Business Deduction, the QBI Deduction, the Pass-through Entity Deduction, the Pass-through Business Deduction and other names. Each of these names refers to the same new deduction.

The QBID is a deduction in the amount of 20% that is allowed for “pass through entities” – sole proprietorships, partnerships, and S corporations (Limited Liability Companies (LLCs) filing as one of the afore-mentioned are included).

To qualify for this 20% deduction, qualified business income must be earned from what is termed a “qualified trade or business.” The deduction reduces taxable income and is 20% of “qualified business income” (or 20% of taxable ordinary income, whichever is less). The deduction is claimed on the individual’s tax returns whether an individual itemizes or does not itemize personal deductions on Schedule A. This deduction is classified as a “below-the-line” deduction as it is taken after adjusted gross income is calculated.

Net Farm Income from Schedule F qualifies for this deduction. Depreciation recapture income and certain rental income also qualifies. Capital gains income does not qualify. The key consideration for farmers is that Net Farm Profit (if any) from Schedule F does qualify for the deduction.

For higher income filers there are limitation phase-ins for this deduction. This deduction is fully available for individuals with taxable income of less than $157,500 for single filers and less than $315,000 for joint filers. (Filers above these thresholds can also qualify if they meet certain criteria.) The deductible amount for EACH qualified trade or business is 20% of the taxpayers qualified business income (QBI) with respect to each trade or business or 20% of the taxpayer’s taxable income, whichever is less.

Example:

You are a sole-proprietor (married filing jointly) and you make $100,000 in net farm income (Schedule F Income) but with the new standard deduction ($24,000) your taxable income is $76,000 (assume the Schedule F net farm income is the sole source of income).

Your deduction is the lesser of:

20% of $100,000 = $20,000

20% of $76,000 = $15,200

Deduction is $15,200

Your taxable income in this simple example will be $60,800 ($100,000 -$24,000 – $15,200).

The QBID is limited for taxpayers with QBI over the threshold amounts of $157,500 for single filers and $315,000 for joint filers. Taxpayers with QBI over these need wages paid (W-2 wages paid) and/or depreciable property to qualify. This “depreciable property” is technically referred to as “Unadjusted basis immediately after acquisition of qualified property” or “UBIA of qualified property” or UBIA for short.

The limitation phase-in ranges are $50,000 for single filers and $100,000 for joint filers which means the limitation phase-in ranges for a single filer is $157,000 – $207,000 and the limitation phase-in range for joint filers is $315,000 – $415,000.

So….once $157,000 and $315,000 are reached, a limitation on the deduction is phased in over the ranges of $50,000 for single filers and $100,000 for joint filers. Taxpayers with taxable income that fall in this limitation phase-in range are subject to a ratable phase-in of the wage and capital limitation which we discuss next.

Once filers reach the top of the phase out ranges ($207,500 for single filers and $415,000 for joint filers) the calculations are relatively simple. The deduction is the lesser of:

  1. QBI for the trade of business (20% x Qualified Business Income) and:
  2. The greater of:
  • 50% of the W-2 wages paid by the business or
  • The sum of 25% of the W-2 wages with respect to the trade or business and 2.5% of the depreciable property (UBIA).

Example:

You are a sole-proprietor (married filing jointly) and you have $500,000 of Net Farm Income (Schedule F Income) but with the new standard deduction ($24,000) your taxable income is $476,000 (assume the Schedule F net farm income is the sole source of income). Assume they pay W-2 wages of $60,000 and have depreciable property of $1.2 million.

As they are above the top end of the limitation phase-in range ($415,000 for joint filers), their QBID will be limited to the lesser of 20% of the QBI ($500,000 x 20% = $100,000) or the greater of the two possible wage/UBIA limiting calculations. We can calculate the potential QBID using both methods and take the higher of the two.

  • $60,000 * 50% = $30,000
  • ($60,000 * 25%) + ($1,200,000 * 2%) = $39,000

We compare the greater of the two ($39,000) to the unlimited QBID of $100,000 and take the lesser of the two or $39,000.

The QBID deduction will be $39,000 for this farm business and for this taxpayer assuming 20% of the Taxable Income isn’t less than this. Taxable income of $476,000 * 20% equals $95,200 therefore the QBID for this tax return will be $39,000 and the Taxable Income will be $437,00 ($500,000 – $24,000 – $39,000).

For purposes of the QBID we provide more details on depreciable property to calculate the QBID in and above the phase-out ranges.

What is the depreciable property (UBIA) for purposes of the QBID? This is defined as tangible property, subject to depreciation (meaning inventory doesn’t count), which is held by the business at the end of the year and is used — at ANY point in the year — in the production of QBI. But there’s a catch: if you’re going to count the basis towards your limitation, the “depreciable period” of the period could not have ended prior to the last day of the year for which you are trying to take the deduction.

The depreciable period starts on the date the property is placed in service and ends on the LATER OF:  10 years, or the last day of the last full year in the asset’s “regular” (not ADS) depreciation period.

To illustrate, assume Ohio Farm purchases a piece of machinery on November 18, 2018 for 100,000. The machinery is used in the business, and is depreciated over 5 years. Even though the depreciable life of the asset is only 5 years, the owners of Ohio Farm will be able to take the unadjusted basis of $100,000 into consideration for purposes of this second limitation for ten full years, from 2018-2027, because the qualifying period runs for the LONGER of the useful life (5 years) OR 10 years.

The basis taken into consideration is “unadjusted basis,” meaning it is NOT reduced by any depreciation deductions. In fact, Internal Revenue Code Section (§) 199A(b)(2)(B)(ii) requires that you take into consideration the basis of the property “immediately after acquisition”. Any asset that was fully depreciated prior to 2018, unless it was placed in service after 2008, will not count towards basis.

Just as with W-2 wages, a shareholder or partner may only take into consideration for purposes of applying the limitation, 2.5% of his or her allocable share of the basis of the property. So if the total basis of S corporation property is $1,000,000 and you are a 20% shareholder, your basis limitation is $1,000,000 * 20% * 2.5% = $5,000.

If you are a partner in a partnership, you must allocate your share of asset basis in the same manner in which you are allocated depreciation expense from the partnership.

Special rules apply for sales to cooperatives and farmland lease income and will be covered in a subsequent articles.

Learn How The New Tax Law Will Affect Your 2018 Farm Return

 

Farmers and farmland owners are invited to register for a two-hour webinar that focuses on the new tax law as it relates to farm returns. The webinar is being hosted by OSU Extension’s Income Tax School Department on Monday, January 7, from 10:00 – noon.

General taxpayer topics to be covered include the new modified tax brackets, standard deductions, elimination of the personal exemption, elimination or change of many Schedule A deductions, the increase in the Child Tax Credit, creation of the new Dependent Credit and an update on education provisions.

Specific farm business and farmland owner-related topics that will be covered:

  • Farm equipment depreciation changes
  • Changes to First Year Bonus Depreciation and Section 179 Expensing
  • Changes to Net Operating Losses
  • Changes to Like Kind Exchanges (farm machinery and equipment no longer are eligible for this provision – this is a significant change)
  • Estate and gift tax update
  • New C-Corporation Tax Rates
  • New Qualified Business Income Deduction (this will impact most farm businesses!)
  • Section 199A Deduction for sales to cooperatives (slightly different from the QBI Deduction for other farm business income and more complex)
  • Which farmland lease income will qualify for the QBI Deduction
  • Tax strategies to consider under the Tax Cuts and Jobs Act

Instructors will be OSU Extension Educators Chris Bruynis and David Marrison, along with Barry Ward, Tax School Director. The cost to attend is $35. To register, visit https://go.osu.edu/FarmerTaxWebinar. For questions, contact Julie Strawser at strawser.35@osu.edu or 614-292-2433.

 

 

Farm Tax Update to Be Held on January 17 in New Philadelphia, Ohio

by: Chris Zoller, Extension Educator

OSU Extension in Tuscarawas County is pleased to be offering a Farm Tax Update on Thursday, January 17 from 1 p.m. to 2:30 p.m. p.m. at the OSU Extension office, 419 16th St. SW, New Philadelphia, Ohio.  OSU Extension Educator David Marrison will share details on the “Tax Cuts & Jobs Act of 2017” and its impact on farm taxes.  It is not business as usual in the world of farm taxes.  Learn more about the changes to farm machinery depreciation, like-kind exchanges, and more about the new Section 199A deduction for Qualified Business Income.  This program is free & open to the public!  However, courtesy reservations are requested so program materials can be prepared. Call the Tuscarawas County Extension office at 330-339-2337 to RSVP or for more information.