Is the 20% Cooperative Deduction Better Than the Regular One – It Depends
The following post is based solely upon how the tax bill is currently written. Until the IRS issues regulations that interpret this new Code Section 199A, it is way to early to make any dramatic changes to your farm operation. However, it is important to communicate what is currently written in the code.
First, if a farm sells all of their products to a non-cooperative, the farm will receive a deduction equal to 20% of net farm income. This deduction may then be limited if the farmer’s taxable income is over $315,000 (MFJ or $157,500 single). In that case, the limit will be the greater of:
- 50% of wages paid by the farmer, or
- 25% of wages paid plus 2.5% of the cost of certain fixed assets.
Once that number is determined, the final limit is 20% of the net of taxable income less capital gains less cooperative distributions (if any). Here is a quick example:
Farmer Mary, a married taxpayer, has Schedule F net income of $300,000. Her taxable income is $250,000. She pays out $150,000 of wages and has qualified assets of $1 million. Her deduction is $60,000 and assuming her income is over the threshold amount, her limit is the greater of $75,000 (50% of $150,000) or $62,500 (25% of $150,000 plus 2.5% of $1 million). Her gross deduction of $60,000 is less than $75,000 so this is her gross deduction. However, 20% of taxable income is only $50,000, therefore, she can deduct $50,000 and reduce her taxable income to $200,000.
The deduction for selling products to a cooperative is simpler and usually results in a larger deduction, but not always. The deduction is simply the total of payments received from the cooperative (including non-cash qualified patronage dividends) times 20%. The ONLY limit is 100% (not 20%) of the net of taxable income minus capital gains. This will usually result in a greater deduction than not selling to cooperative. However, the IRS has not yet issued regulations on any of these definitions or interpretations, so for now, we can make certain assumptions based upon a literal reading of the new Section 199A Code Section, but this may change and the change may be material. Let’s look at an example:
Assume Farmer Mary has gross sales to a cooperative of $1,500,000. In this case, her Section 199A deduction would be $300,000 ($1,500,000 times 20%). Her taxable income is $250,000, therefore her net deduction is $250,000 reducing taxable income to zero. However, let’s now assume that her taxable income is comprised solely of capital gains. In this case, her gross Section 199A deduction is still $300,000, but her allowed deduction is taxable income of $250,000 less capital gains of $250,000 which results in zero Section 199A deduction allowed. Even though her deduction was $300,000, it did not save her a dime of tax.
Many or our dairy operations will fall into this trap which was explained in this post.
Therefore, the bottom line is that based on how the Code is written now, the new Section 199A deduction for selling farm products to cooperatives will yield a greater deduction in 2018 than selling to non-cooperatives. However, in many cases the extra deduction will result in no additional tax saved. Until we get proposed regulations from the IRS regarding this subject, care must be taken in making any structural changes to your farm operations. It is likely that in selling your products to a cooperative, you will be no worse off than not selling to it, and in most cases the tax result will be better.
There will be many strategies proposed to take advantage of this extra deduction. However, it is likely better to wait for additional IRS guidance before implementing any major changes.
We will keep you posted.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
In your second example, you suggest that the Section 199A deduction for Mary is 20% of her gross sales to the cooperative even though the statute refers only to her qualified business income (which would be reduced by business expenses) and qualified cooperative dividends (which receipts from sale of grain would not be). This ultimately proved irrelevant due to the limitation you further elaborate on in the example, but clarification as to this point would be helpful.