Why Did They Call It 199A?
On our last post, we got the following comment:
“If a farmer operates as a ‘C’ Corporation and is a member of a farm cooperative to which the corporation sells grain, are the cooperative sales proceeds eligible for the 20 percent sec 199A deduction? Corporations were eligible for the Sec 199 deduction so why not the Sec 199A deduction?”
We continue to get comments or questions just like this and I thought it would be good to give a little more detail on this deduction since there appears to be a lot confusion between Section 199 and 199A.
The old Section 199 was a 9% deduction to promote domestic production activities (DPAD). It was available for most business activities that generated some type of production such as farmers. It did not matter if you were taxed as a corporation or a flow-through. It had a limit based on 50% of wages paid by the entity and cooperatives could either retain their DPAD or pass it through to their patrons.
As Congress was setting up the new tax law, the old Section 199 was removed from both the House and the Senate bill. There would no longer be any Section 199 deduction for any taxpayer.
However, since corporations were getting a reduction in their tax rate from 35% to 21%, Congress elected to provide a new deduction that would allow all non corporate taxpayers to reduce their tax rate on almost any business income by a new Section 199A 20% deduction. If your tentative taxable income is under $315,000 (married couples) or $157,500 for all others, then any business will qualify for the 20% deduction limited to 20% of taxable income minus capital gains minus cooperative payments to their patrons.
It would have been much cleaner if Congress had created a new Code Section number such at 1XX. This deduction has nothing to do with production activities and although some of the limits are similar, it just creates confusion among taxpayers.
Remember, if you are a corporation, no 20% Section 199A deduction is allowed since your tax rate has been reduced from 35% to 21% (although many farmers have a 40% tax increase since they took advantage of the lower 15% tax rate on the first $50,000 of corporate taxable income). Farmers who farm as a C corporation will need to review if it continues to make sense to be taxed as a C corporation or switch to an S corporation.
Also, remember the new Section 199A 20% deduction is scheduled to expire after 2025, but the elimination of DPAD is permanent. And as discussed in previous posts, it is highly likely that the 20% cooperative deduction for farm patrons will likely change soon and the benefit may be materially reduced.
Let’s look at an example:
ABC Farm Corporation generated $55,000 of net taxable income in 2017 and then received a DPAD from it’s cooperative of $5,000. This brought its taxable income to $50,000. The tax on this was $7,500. In 2018, it reports that same amount of income. The new tax is $11,550 ($55,000 X 21%), or an increase of $4,050 or 54% increase. The old rate of 15% is now 21% and the corporation no longer gets DPAD from the cooperative.
However, usually the primary reason for setting up a farm corporation is to provide tax-deductible housing and meals to owners that are then tax-free to the owner. This benefit still remains other than meals are only 50% deductible now instead of 100% as was true under the old law (in most situations).
Therefore, simply because your tax rate may go up and you don’t get either Section 199 or 199A deduction, C corporations will still make sense for many farm operations. You should discuss this with your tax advisor especially after guidance is received from the IRS on Section 199A.
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.
For the average C-corporation farming operation that seems to be completely out of luck with the new tax plan, how about creating a new pass through entity and essentially treating it as a “brokerage”? The C-corp farm could remain intact and continue to be the farming entity, however all of the commodities would be sold to the Co-op through this new entity that would take a certain “cut” of every bushel. The margins of this brokerage entity could be managed in a way that would provide an adequate amount of net income to take advantage of the 20% deduction. The income of the C-corp would be significantly reduced, but that would be offset by owners taking withdrawals from the new entity rather than wages from the corporation.