February 12, 2018
SECTION 199A OF THE NEW TAX LAW
For the most part, farm operators and farm businesses were satisfied with the “Tax Cuts and Jobs Act of 2017” that was passed by Congress and enacted into law late last year. There were provisions to lower individual and corporate tax rates, provisions to extend depreciation deductions, as well as a provision to double the Federal estate tax deduction. However, as time has progressed since the implementation of the new tax law, the part of the legislation that has been garnering the most attention in agricultural circles is the new “Section 199A” provision, which creates a pass-through tax deduction for income to and from qualified business entities.
The Section 199A deduction applies to income earned by pass-through business entities, such as sole proprietorships, partnerships, S-corporations, etc. The income earned by these types of entities is not taxed directly; however, it is passed through to the tax returns of the individual owners, such as Schedule F for Federal tax returns filed by farm businesses. The intent of including Section 199A in the recently passed tax law is to ensure that farm businesses and other business entities, which are not C-corporations, receive similar tax benefits through the legislation as those received by the corporations. The tax law reduced the maximum tax rate for C-corporations from 35 percent to 21 percent.
The Section 199A provision also retained a deduction for cooperatives that was eliminated when the previous Section 199 was removed during the drafting of the new tax law. The provision provides a 20 percent deduction on “qualified cooperative dividends”. Typically, these would be thought of as the patronage dividends by cooperatives to their membership, which will now again be covered by the new legislation. However, the new legislation also now covers the payments made by cooperatives for grain and other agricultural products, which was not part of any previous tax legislation.
Under normal circumstances, if a farm operator sells grain or farm products, the farm business entity can take a 20 percent tax deduction of the net profit (gross sales minus qualified expenses) when calculating their taxable income. This provision will still be in place under the new tax law on the proceeds for grain or agricultural products that are received from a grain warehouse, processing plant, or other farm business that is not a cooperative. However, under the new Section 199A provision, grain and agricultural products that are sold through a cooperative will receive a 20 percent tax deduction on the gross sales, rather than on the net profit. The Section 199A provision applies to grain and agricultural products sold by farm business entities that are set up as sole proprietorships, partnerships, and S-corporations, but not to farm businesses set up as C-corporations.
An example of how this could affect an independent grain farmer with gross sales of $500,000, total expenses of $450,000, and net income of $50,000 for a given year, would be as follows:
- If the grain is sold to grain firm, processing plant, ethanol plant or livestock producer that is not cooperative, there would be a tax deduction of $10,000 ($50,000 net income times 20 percent).
- If the grain is sold through a cooperative, the total potential tax deduction would be over $100,000 ($500,000 gross sales times 20 percent), plus 20 percent of the cooperative dividend.
Many professionals in the grain industry feel that the new Section 199A provision creates an unfair incentive for cooperatives in the grain procurement industry. However, some farm organizations and others have pointed to the significant corporate tax reduction that was included in the new tax law as a major benefit to corporations that is not available to other types of business entities. Some members of Congress have been working on drafting legislation to make corrections Section 199A language, citing that the current language exceeded the intent of the legislation. The two-year budget deal recently passed by Congress did not include any provisions to correct or adjust the Section 199A provision.
Most tax experts feel that eventually the Section 199A provision will be adjusted by Congress; however, it is not known what that adjustment may look like, or when it will take effect. Some farm operators have been selling grain to cooperatives since January 1, 2018, which raises some questions regarding 2018 Federal income tax calculations …… Will those grain sales qualify for the Section 199A as it now stands, or will any adjustments be retroactive back until the beginning of the year ? Also, what will be the impact on grain that is now being forward priced now cooperatives for future delivery later this year ? It may be a while before we know the answers to those questions.
Farm operators are encouraged not over-react to the Section 199A provision when comparing various grain bids. First of all, the potential added tax deduction available by selling grain through a cooperative, if it occurs at all, is only a benefit to a farm business entity that has a high enough taxable income level to utilize the deduction. It may not be worth sacrificing a higher price quote from an ethanol plant or processing plant just to receive the added tax deduction available by selling the grain through a cooperative at a lower price.
Some farm operators have also talked of working with other farmers to form new cooperative business entities to take advantage of the recently enacted Section 199A tax provision. However, tax experts advise caution before proceeding with restructuring farm business entities simply to adjust to the new legislation, which could be changed in the future. In addition, the Internal Revenue Service (IRS) may offer some guidance or interpretation regarding taxation under the new Section 199A provision. The best advice for farm operators at this point is to be patient, and to consult with a certified public accountant (CPA) or tax accountant regarding the potential impacts of the new Section 199A tax provision on their farm business for 2018 and beyond.
Note — For additional information contact Kent Thiesse, Farm Management Analyst and Senior
Vice President, MinnStar Bank, Lake Crystal, MN. (Phone — (507) 381-7960);
E-mail — (firstname.lastname@example.org)