Prior to 2018, U.S. manufacturers, including farmers’ cooperatives, enjoyed a lucrative income tax deduction popularly known as the Domestic Production Activities Deduction (DPAD). Under former Internal Revenue Code § 199, a U.S. manufacturer could deduct the lesser of 9% of manufacturing income or 50% of wages paid to manufacturing employees. Form W-2 wages paid by the manufacturer were a limit to the deduction because the DPAD was intended to promote domestic employment. Cooperatives could pass this deduction through to their members on Form 1099-PATR.
The Tax Cuts and Jobs Act of 2017 (TCJA) repealed the DPAD for everyone, including cooperatives, in exchange for the new Qualified Business Income Deduction under Internal Revenue Code § 199A. Initially, § 199A as codified in the TCJA allowed cooperative members to deduct 20% of their gross proceeds from the sale of grain, livestock, and other commodity to cooperatives when computing their taxable income (per-unit retains paid in money).
Unlike the Qualified Business Income (QBI) Deduction, which is limited by W-2 wages and the unadjusted basis of qualifying property, this “qualified cooperative dividend” deduction under the TCJA was limited only by taxable income. A great hullabaloo in farm country followed enactment of this so-called “grain glitch,” and Congress rushed to repeal it. Congress did so in the Consolidated Appropriations Act of 2018, applying the change retroactively.
Congress wanted to preserve something in § 199A for cooperatives, so the Consolidated Appropriations Act of 2018 trifurcated § 199A for farmers.
But if he sells a commodity to a cooperative of which he is a member, he does two computations.
Congress is reducing his QBI deduction by up to 9% in this application because it also reinstated the 9% DPAD just for cooperatives. Cooperatives will compute a DPAD based on manufacturing sales and wages, just like they did before 2018.
For example, assume that Jane Farmer is a self-employed grain farmer with no employees. She sells her grain to an Iowa cooperative in 2018 for total cash proceeds of $100,000 which was her only gross income for the year. Jane will prepare and file IRS Schedule F, Profit or Loss from Farming, for 2018. She will compute her QBI deduction on a yet-to-be-published IRS form. It will import income and expense data from Schedule F including data regarding W-2 wages (in this case zero). We will assume that Jane’s net Schedule F income, before the QBI deduction, is $20,000. Jane’s tentative QBI deduction is $4,000 (20% of $20,000). Because she has no W-2 wages, Jane will reduce her tentative QBI by $ 1,800 (9% of $20,000). On the new QBI form she will compute a QBI deduction of $2,200 ($4,000-$1,800) which she will deduct on Schedule F. This will leave her with Schedule F income of $17,800 ($20,000-$2,200) before any DPAD.
If a cooperative generates a DPAD and wants to utilize the DPAD to reduce cooperative income, then it may. If not, it may pass all or a portion of the DPAD through to cooperative members on Form 1099-PATR just like it has historically. When the DPAD is passed through to the farmer member, § 199A allows him to deduct that portion on his tax return like he did before 2018. To the extent that Jane Farmer’s cooperative distributes to her any part of the 9% DPAD, she will show and deduct this amount also on Schedule F. To the extent that Jane’s cooperative either does not generate a DPAD or generates and uses the entire DPAD at the cooperative level, Jane nonetheless gets only an 11% QBI deduction (20%-9%) related to her sales to cooperatives, while she gets the full 20% QBI deduction for sales to all other grain buyers.
If all of this seems complicated to you, then it may be comforting to know that the Treasury Department thinks so too. Although the Treasury released its proposed regulations for the rest of § 199A on August 16, 2018, it did not also release those related to the cooperative DPAD and the various § 199A adjustments for farmers. The Treasury has promised to release those later in 2018. Maybe they will provide something different. We will keep you updated.