The 2017 Tax Cuts and Jobs Act included a provision that created quite a stir in the ag sector. The Qualified Business Income Deduction, a/k/a “Section 199A Deduction,” appeared to create a distinct income tax advantage for producers selling their product through cooperatives.This inadvertent result was addressed, and the tax treatment of Section 199A (“199A”) for co-ops was revised on March 23, 2018, with the signing of a government spending bill. This article provides a brief overview of 199A and outlines the provisions of the recent corrections.
199A General Overview
199A applies to businesses that are not taxed as C corporations. The primary purpose of 199A is to even the tax playing field between C corporations and other businesses not taxed as C corporations. In general, 199A provides qualified taxpayers with a special deduction equal to 20% of net business income. The deduction is computed on the individual’s income tax return and can be influenced by tax characteristics of the business, whether it is a proprietorship, S corporation, partnership, or trust/estate. The deduction cannot offset capital gain income in many cases.
There are some limitations if the taxpayer’s 199A pre-taxable income exceeds $315,000 (married filing jointly) or $157,500 (single). If income exceeds these levels and the taxpayer is in a specified service business, then no 199A deduction is allowed. If income exceeds these levels and the taxpayer is not in a specified service business, then the deduction is limited by a special calculation. This special limit is defined as the greater of:
- Fifty percent of the taxpayer’s allocable share of W-2 wages paid by the business; or
- The sum of the taxpayer’s allocable share of 25% of the W-2 wages paid by the business, plus the taxpayer’s share of 2.5% of the original purchase price of assets owned by the business.
To summarize so far, the deduction is simple if the taxpayer falls under the income limitations. A reduction of taxable business profits of 20% could result in significant tax savings for many farm and ranch operations.
The Co-op Fix
The original wording of 199A indicated that producers who sold their commodities through a co-op would receive a deduction equal to 20% of the gross sales made through the co-op. This clearly was not the intent of Congress, and 199A was corrected, with final passage and signing of the corrective legislation on March 23, 2018.
The corrected 199A provides for a two-part approach. The first part can be passed through from the co-op to the patron and/or taken at the co-op level. This part is limited to the lesser of 9% of the co-op’s taxable income or 50% of wages paid by the co-op. If the co-op passes the deduction through to its patrons, this part of the deduction is limited only by the overall taxable income of the taxpayer’s qualified farm business, including an offset of business capital gain income. Consistent with the original 199A, this deduction is not allowed for C corporations.
The second part of the deduction is a patron-level deduction. This deduction is equal to 20% of net farm income minus capital gains and minus the lesser of 9% of farm net income or 50% of wages paid. In a nutshell, this will probably result in a deduction equal to 11% of qualified taxable income.
This calculation will get more complicated if the farmer sells product to both cooperatives and non-co-op outlets. Farmers who do this will need to separately identify the income and expenses and apply 199A to the co-op and non-co-op portions of their net profit.
Clearly, there are opportunities to evaluate how 199A affects the tax on your operations. It can be a significant factor in comparing the tax impact of operating through a C corporation as compared to the other options available. Several factors come into play, and careful analysis is needed to evaluate the options.
As this article goes to press, no Treasury regulations are written yet, so significant uncertainties exist related to knowing whether rental activities qualify for the 199A deduction. Also, how to address situations in which the income threshold is exceeded by a combination of qualifying business profit and profit from a specified service business is not known.
Producers should evaluate the impact of 199A on their tax position and consult with tax professionals to understand the full impact on their own structure. If you have questions, please contact your Wipfli relationship executive, or I can be contacted at firstname.lastname@example.org.