The 20% Deduction for Qualified Business Income

This post is the last of three posts from Rebecca Smith, our director of cooperative taxation regarding the new Section 199A 20% business deduction for farmers who also receive distributions from coops.  We will be doing additional posts on this subject over the next several weeks as we learn more on the best way to maximize this deduction.

Over the last couple days we have had several questions as to how the 20% deduction for qualified business income will work for a farm. Below we explain how the deduction is calculated and provide some examples. Based on our analysis, this deduction will be very beneficial to individuals doing business with a cooperative.

20% deduction for qualified business income (New)

    • Effective tax years beginning after December 31, 2017 and before January 1, 2026
    • Equal to the sum of
      • The lesser of
        • Combined qualified business income amount of the taxpayer or
        • 20% of the excess, if any, of the taxpayers’ s taxable income over the sum of any net capital gain and qualified cooperative dividends
      • Plus the lesser of
        • 20% of qualified cooperative dividends (Qualified cooperative dividends include patronage dividends, per-unit retain allocations, qualified written notices of allocations, or similar amounts) or
        • Taxable income reduced by the net capital gain
    • Combined qualified business income amount equals
      • Sum of the amounts for each qualified trade or business
        • Lesser of
          • 20% of the taxpayers qualified business income with respect to the qualified trade or business or
          • The greater of
            • 50% of the W2 wages with respect to the qualified trade or business or
            • The sum of 25% of W2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis of all qualified property
        • Note: Individuals with income less than $157.5K ($315K joint) will not be subject to the 50% wage limitation
      • Plus 20% of the taxpayer’s qualified REIT dividends and qualified publicly traded partnership income
    • Qualified business income = the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business (excludes REIT dividends, qualified cooperative dividends, or qualified publicly traded partnership income)
    • Note: Not a deduction to arrive at adjusted gross income (AGI)

Example 1: A farm earns $300K, pays wages of $125K, has gross cooperative distributions of $3M, and has original asset cost of $750K. The taxpayer files married filing joint. The amount deductible is calculated as follows:

Equal to the sum of

    • The lesser of
      • $0 Combined qualified business income (20% x ($300K-$3M)) Note: Since the taxpayer’s income is less than $315K the wage limitation does not apply
      • $0 (20% x ($300K-($0K+$3M)
    • Plus the lesser of
      • $600K = 20% qualified cooperative dividends (20% x $3M)
      • $300K = Taxable income reduced by net capital gain
      • The farmer can deduct the $300K, bringing their taxable income to zero.

Example 2: Same facts as example 1, except the farm earns $400K. The amount deductible is calculated as follows:

Equal to the sum of

    • The lesser of
      • $0 Combined qualified business income (lesser of 20% x ($400K-$3M) or greater of (50% x $125K) or (25% x $125K plus 2.5% x $750K)
      • $0 (20% x ($400K-($0K+$3M)
    • Plus the lesser of
      • $600K = 20% qualified cooperative dividends (20% x $3M)
      • $400K = Taxable income reduced by net capital gain
      • The farmer can deduct the $400K, bringing their taxable income to zero.

Example 3: Same facts as example 1, except the farm earns $1M. The amount deductible is calculated as follows:

Equal to the sum of

    • The lesser of
      • $0 Combined qualified business income (lesser of 20% x ($1M-$3M) or greater of (50% x $125K) or (25% x $125K plus 2.5% x $750K)
      • $0 (20% x ($1M-($0K+$3M)
    • Plus the lesser of
      • $600K = 20% qualified cooperative dividends (20% x $3M)
      • $1M = Taxable income reduced by net capital gain
      • The farmer can deduct the $600K, bringing their taxable income to $400K.
  • Principal
  • CliftonLarsonAllen
  • Yakima, Washington
  • 509-823-2920

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 Yakima, 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. In fact, Paul drives combine each summer for his cousins and that is what he considers a vacation. Leave a comment for Paul. If you would like to leave a comment for Paul, follow the link above, however, please make sure to include your email address so that he can reply to your comment (your email address will not automatically show up).

Comments

Treating the gross grain sales as per-unit retains was just started with the DPAD deduction/treatment/lingo/etc. Now that that part of Sec 199 is gone (basically replaced by this new 20% deduction) I’m guessing your 2018 1099-PATR will not have your gross grain sales in Box 3 as a per unit retains/patronage. That was allowable under DPAD, DPAD is gone. I’m guessing there will be some corrective literature, etc here. Otherwise basically no farmer, ever, would pay income tax, unless you operate at a 20% or higher profit. Heck, any one with a net margin under 20% would have negative income. Not likely to play out this way, IMO.

My questions are the following:

Does qualified business income for sole proprietorships (C & F) and partnerships not paying any guaranteed payments end up being 30% of the net income with the assumption that 70% will be treated as reasonable compensation? (your example of $300,000 X 30% X 20% = $18,000)

Do the calculations in your example need to be netted. In other words does taxable income reduced by the per unit retain allocation which produces a negative number significantly reduce the second half of the calculation of per unit retain allocation times 20% ($300k – 3M = $2.7M X 20% = -$540,000 + 18,000 (from above) + $600,000 = $78,000)

The 70/30 rule did not make it into the final bill. SE tax will be calculated the same.

On the Section 199A deduction, any negative in the first part is suspended and carry forward to the next year, therefore, the second part is allowed.

What am I giving up selling directly to a non-coop ethanol plant?

By selling $10000.00 worth of corn, am I giving up a $2000.00 tax deduction?

What if I sell my grain through a coop and deliver it to an ethanol plant? In this example the coop pays me.

Will commodity wages qualify as W-2 wages for the Sec. 199A deduction calculations?

No. It has to be wages subject to withholding.

If I’m correct, your assumptions hinge on the fact that coops treat purchases of milk or grain as per-unit retains allocations. Under the old system, this created a larger DPAD deduction for the cooperative so there was an incentive to do so. With the new law, is the opposite true? Is there still an incentive for a coop to treat grain or milk purchases as per-unit retain allocations? If not, your examples overstate the benefit significantly.

That is correct and there has been no change to that method in the code, etc.

Coops would still get a 20% deduction equal to their gross revenues less payments to patrons limited to taxable income so they would still likely have no taxable income

Would love to see a response to the questions/comments noted above. It seems unreasonable that a farmer would be allowed a deduction for 20% of gross income from grain sales to the cooperative.

I’m just a lowly farmer, but it seems like the examples wrongly confuse gross corporate distributions ($3m in the examples) for qualified corporate dividends (such as patronage, etc) in calculating the second half of the deduction (where they find the $3m x 20% to get a $600k max potential deduction) In other words, I don’t see this as being nearly as generous as it appears in the example. I hope to be proven wrong.

Unblieveable! So essentially the deduction will always be 20% if coope income limited to taxable income. Do private grain buyers know what just hit them?

Leave a Reply

Your email address will not be published. Required fields are marked *

Subscribe to Our Email List

* indicates required