On June 19, the U.S. Department of the Treasury and the IRS published proposed regulations providing guidance to cooperatives and their patrons regarding the deduction for qualified business income (QBI) under IRC Section 199A(a), as well as guidance to specified agricultural or horticultural cooperatives and their patrons under IRC Section 199A(g). Final regulations on the QBI deduction were published in January 2019.
As originally enacted in the Tax Cuts and Jobs Act of 2017, IRC Section 199A(g) gave farmers who marketed their crops through a cooperative a distinct tax advantage (known as the “grain glitch”) over farmers who did not do business with a cooperative. This glitch was removed in the Consolidated Appropriations Act of 2018 (CAA). The new proposed regulations focus on IRC Sections 199A(b)(7) and 199A(g), which apply only to agricultural or horticultural cooperatives (specified cooperatives) and their patrons. A cooperative that is solely engaged in providing supplies, equipment, or services to farmers or other cooperatives is not a specified cooperative.
IRC Section 199A(g) provides a special pass-through deduction for specified cooperatives and their patrons similar to the now-repealed domestic production activities deduction under IRC Section 199. Under the new law, a specified cooperative may pass all, some, or none of the IRC Section 199A(g) deduction through to its patrons, other than C-corporation patrons. The transition rule in Section 101 of the CAA provides that patrons are barred from using qualified payments (which include patronage dividends and similar payments described in IRC Section 1388 such as qualified written notices of allocation and qualified per-unit retains) received from the cooperative to compute their IRC Section199A(a) deduction to the extent the payments were attributable to the cooperative’s IRC Section 199 deduction allowable in a taxable year beginning before Jan. 1, 2018.
Nonexempt cooperatives under IRC Section 1381(a)(2) can take into account only gross receipts and related deductions from sources related to business done with or for members (patronage sourced) to calculate their qualified production activities income under IRC Section 199A(g)(3), and they no longer can use nonpatronage source production activity income to offset the cooperative’s nonpatronage income. Under IRC Section 199A(g)(3), qualified production activity income is the same as under the repealed Section 199. Generally, for any taxable year, it is the amount equal to the excess (if any) of the taxpayer’s domestic production gross receipts over the sum of cost of goods sold allocable to such receipts and other expenses, losses, or deductions properly allocable to such receipts.
Exempt farmer cooperatives under IRC Section 521 must separately calculate patronage-sourced production activity income and nonpatronage-sourced production activity income. Any nonpatronage-sourced production activity income is not qualified production activity income and cannot be passed through to members. In contrast to rules for nonexempt cooperatives, nonpatronage source production activity income can be used to offset an exempt cooperative’s nonpatronage income. Exempt farmer cooperatives that do not have nonpatronage activity do not have to make two calculations.
IRC Section 199A(b)(7) requires patrons to reduce their QBI deduction by the lesser of 9% of QBI related to the qualified payments received from the specified cooperative, or 50% of W-2 wages allocable to qualified payments received from the specified cooperative. Section 1.199A-7(f)(2)(i) of the proposed regulations provides that patrons receiving both qualified payments and income that is not a qualified payment in a trade or business must allocate those items and related deductions using a reasonable method. Patrons with income under certain thresholds ($315,000 for joint filers and $157,500 for all other taxpayers) are eligible to use the safe harbor provided in Section 1.199A-7(f)(2)(ii) of the proposed regulations. Under the safe harbor, eligible patrons may determine the IRC Section 199A(b)(7) reduction by apportioning their qualified trade or business deductions and W-2 wages ratably between income from qualified payments and income from other sources.
Section 1.199A-7(c)(3) of the proposed regulations also requires increased reporting by all cooperatives, not just specified cooperatives. Specifically, cooperatives that make qualified payments to patrons must determine the amount of qualified items of income, gain, deduction, and loss inherent in those distributions and report those items on, or on an attachment to, the Form 1099-PATR, “Taxable Distributions Received From Cooperatives,” issued by the cooperative to the patron. If the cooperative does not report these items to the patron by the due date of the 1099-PATR, the amount that can be included in the patron’s QBI calculation is presumed to be zero.
The preamble to the proposed regulations provides that taxpayers may rely on the proposed regulations until they are adopted as final regulations only if taxpayers apply the rules in their entirety and in a consistent manner. Comments and requests for a hearing are due on Aug. 19, 2019.
As originally enacted in the Tax Cuts and Jobs Act of 2017, IRC Section 199A(g) gave farmers who marketed their crops through a cooperative a distinct tax advantage (known as the “grain glitch”) over farmers who did not do business with a cooperative. This glitch was removed in the Consolidated Appropriations Act of 2018 (CAA). The new proposed regulations focus on IRC Sections 199A(b)(7) and 199A(g), which apply only to agricultural or horticultural cooperatives (specified cooperatives) and their patrons. A cooperative that is solely engaged in providing supplies, equipment, or services to farmers or other cooperatives is not a specified cooperative.
IRC Section 199A(g) provides a special pass-through deduction for specified cooperatives and their patrons similar to the now-repealed domestic production activities deduction under IRC Section 199. Under the new law, a specified cooperative may pass all, some, or none of the IRC Section 199A(g) deduction through to its patrons, other than C-corporation patrons. The transition rule in Section 101 of the CAA provides that patrons are barred from using qualified payments (which include patronage dividends and similar payments described in IRC Section 1388 such as qualified written notices of allocation and qualified per-unit retains) received from the cooperative to compute their IRC Section199A(a) deduction to the extent the payments were attributable to the cooperative’s IRC Section 199 deduction allowable in a taxable year beginning before Jan. 1, 2018.
Nonexempt cooperatives under IRC Section 1381(a)(2) can take into account only gross receipts and related deductions from sources related to business done with or for members (patronage sourced) to calculate their qualified production activities income under IRC Section 199A(g)(3), and they no longer can use nonpatronage source production activity income to offset the cooperative’s nonpatronage income. Under IRC Section 199A(g)(3), qualified production activity income is the same as under the repealed Section 199. Generally, for any taxable year, it is the amount equal to the excess (if any) of the taxpayer’s domestic production gross receipts over the sum of cost of goods sold allocable to such receipts and other expenses, losses, or deductions properly allocable to such receipts.
Exempt farmer cooperatives under IRC Section 521 must separately calculate patronage-sourced production activity income and nonpatronage-sourced production activity income. Any nonpatronage-sourced production activity income is not qualified production activity income and cannot be passed through to members. In contrast to rules for nonexempt cooperatives, nonpatronage source production activity income can be used to offset an exempt cooperative’s nonpatronage income. Exempt farmer cooperatives that do not have nonpatronage activity do not have to make two calculations.
IRC Section 199A(b)(7) requires patrons to reduce their QBI deduction by the lesser of 9% of QBI related to the qualified payments received from the specified cooperative, or 50% of W-2 wages allocable to qualified payments received from the specified cooperative. Section 1.199A-7(f)(2)(i) of the proposed regulations provides that patrons receiving both qualified payments and income that is not a qualified payment in a trade or business must allocate those items and related deductions using a reasonable method. Patrons with income under certain thresholds ($315,000 for joint filers and $157,500 for all other taxpayers) are eligible to use the safe harbor provided in Section 1.199A-7(f)(2)(ii) of the proposed regulations. Under the safe harbor, eligible patrons may determine the IRC Section 199A(b)(7) reduction by apportioning their qualified trade or business deductions and W-2 wages ratably between income from qualified payments and income from other sources.
Section 1.199A-7(c)(3) of the proposed regulations also requires increased reporting by all cooperatives, not just specified cooperatives. Specifically, cooperatives that make qualified payments to patrons must determine the amount of qualified items of income, gain, deduction, and loss inherent in those distributions and report those items on, or on an attachment to, the Form 1099-PATR, “Taxable Distributions Received From Cooperatives,” issued by the cooperative to the patron. If the cooperative does not report these items to the patron by the due date of the 1099-PATR, the amount that can be included in the patron’s QBI calculation is presumed to be zero.
The preamble to the proposed regulations provides that taxpayers may rely on the proposed regulations until they are adopted as final regulations only if taxpayers apply the rules in their entirety and in a consistent manner. Comments and requests for a hearing are due on Aug. 19, 2019.
