On December 22, 2017, Congress’ new tax reform bill became law as Public Law 115-97 (the “Act”). The Act substantially amends the Internal Revenue Code including provisions that directly impact cooperatives. This post is the first in a series that discusses these provisions. It covers a new deduction for certain cooperatives and a deduction for cooperatives’ members and patrons.
New Section 199A Deduction Available to Cooperatives
The Section 199 deduction for domestic production activities was repealed and effectively replaced with Section 199A(g), which creates a 20 percent deduction for certain income of “specified agricultural or horticultural cooperatives.”
- Deduction Amount
The deduction equals 20 percent of gross income over qualified cooperative dividends “paid during the taxable year.” For this purpose, “qualified cooperative dividends” are patronage dividends, per-unit retain allocations, and qualified written notices of allocation, but only if such amounts are includible in gross income.
The use of the phrase “paid during the taxable year” is interesting because most patronage dividends are not paid during the taxable year the underlying income is earned (and taxed), but are paid during the “payment period for the taxable year” (which extends from the taxable year until 8 months and 15 days thereafter). Based on the language of the Act, however, the deduction is calculated based on patronage dividends paid during the actual taxable year, without regard to the additional 8 ½ months thereafter (which presumably would be considered the following taxable year).
The deduction is subject to various limitations. It cannot exceed (i) 50 percent of W-2 wages or (ii) 25 percent of W-2 wages plus 2.5 percent of unadjusted basis of all qualified property. “W-2 wages” include all employee wages and certain elective deferrals. “Qualified Property” is tangible, depreciable property used at any time in the year for the production of qualified business income. In addition, the deduction cannot exceed taxable income.
- Eligible Cooperatives
The deduction is available for “specified agricultural or horticultural cooperatives,” which is defined as Subchapter T cooperatives that are engaged in the manufacturing, production, growth, or extraction of an agricultural or horticultural product; the marketing of such products for patrons; or providing supplies, equipment, or services to such organizations or farmers.
New Section 199A Deduction Available to Patrons and Members
The better-known impact of new Section 199A authorizes a 20% deduction for certain pass-through income. For cooperative patrons and members, such pass-through income includes “qualified cooperative dividends.” This term includes any patronage dividend, per unit retain allocation, or qualified notice of written allocation that is includable in gross income and received from a Section 501(c)(12) cooperative, Subchapter T cooperative, or common law cooperative. The deduction is subject to various limitations, including taxable income less net capital gains. The total Section 199A deduction cannot exceed taxable income for the year less net capital gains.
Stay tuned to AHC’s Cooperative Law Blog posts to learn about other provisions in the Act. They will include posts about contributions in aid of construction (Section 118); limitation on interest deductions (Section 163); unrelated business income tax (Section 512); excess compensation (Section 4960).
Read other Cooperative Tax posts.