Tax Reform Act Impacts Cooperatives, Part V: New Developments for Cooperatives Under Section 199A

Over the past year, we have been posting on the tax bill passed on December 22, 2017, as Public Law 115-97 (the “Original Act”).  The Original Act substantially amended the Internal Revenue Code including provisions that directly impact cooperatives.  Prior posts have addressed:

But for new Section 199A, the story does not end with the Original Act.  Shortly after passing the Original Act, many stakeholders in the agricultural industry noted a potential advantage granted to agricultural cooperatives that was not available to other agricultural companies.  This advantage/disadvantage is called the grain glitch.

In short, under the Original Act, cooperative patrons received a Section 199A deduction for 20 percent of their qualified business income (“QBI”) plus 20 percent of their patronage dividends, which includes per unit retains paid in money, all subject to various limitations.  Farmers who sold product to non-cooperatives received the deduction based solely on QBI (which is calculated on a net, after -cost basis).

In response to the grain glitch, Congress acted quickly to amend new Section 199A.  By Public Law 115-141, Section 101 (“New Act”), Congress adjusted Section 199A to limit the deduction available to patrons of agricultural cooperatives.  The deduction still remains for 20 percent of QBI.  But the deduction associated with patronage dividends must be reduced by the lesser of (i) 9 percent of QBI associated with the patronage or (ii) 50 percent of W-2 wages.  With this change, the deduction for agricultural cooperative patrons is much more limited than before.

Notably, the New Act added a provision that implies Subchapter T patronage dividends qualify for the Section 199A deduction.  To explain, Section 199A lists several types of income that do not qualify as QBI and is thus unavailable for the deduction.  While dividends are excluded from QBI, the New Act explicitly states that Subchapter T patronage dividends (i.e., those under Section 1385(a)(1)).   A committee report explicitly supports this interpretation.