The recently passed budget bill contains a "fix" for the Section 199A dilemma with respect to sales to cooperatives. As such, it's appropriate to review the changes to get an idea of how it will work.
For non-corporate farmers, the changes to Section 199A will have minimal detrimental effect compared to the pre-2018 Section 199 provision. Section 199A's deduction is limited to 20% of the taxpayer's ordinary income, except for the pass-through deduction from a cooperative (discussed below).
Lower-income farmers may claim a deduction equal to 20% of qualified business income. A high-income farmer's deduction may be limited to the greater of 50% of W-2 wage expense or 25% of wages plus 2.5% of qualified investment in depreciable property (the wage/investment limitation).
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In almost all cases, Section 199A will result in a larger deduction than under the pre-2018 Section 199, Domestic Production Activities Deduction (DPAD). At worst, a farmer will get an 11% deduction. This is greater than then 9% under DPAD, which was limited by 50% wages paid. Under DPAD, if you had no wages, the only DPAD that could be claimed was the amount of DPAD passed through a cooperative.
For those non-corporate farmers selling to cooperatives, a deduction equal to 20% of net business income on such sales, subject to wage or wage/investment limitations, is available. The deduction will be reduced by an amount equal to the old DPAD benefit (9% of net income from sales to a co-op or 50% wages attributed to those sales). In addition, the farmer will be able to claim the pass-through deduction from the cooperative, regardless of character of income, wages or qualified investment in depreciable property.
Farmers that operate as a C corporation may or may not benefit from the new 199A. Under the new law, C corporations are not entitled to any Section 199A deduction. As a tradeoff, C corporations' tax rates dropped from a maximum 35% to a flat 21%. That is a 40% tax reduction. However, if the farm C corporation taxable income was always under $50,000, it was previously taxed at 15%. The increase to 21% is a 40% tax increase. The purpose of the Section 199A deduction is to lower the business tax rate for non-corporations to level the playing field.
We are still waiting for IRS guidance on many issues with Section 199A, including guidance on whether farm rental income qualifies for the deduction. But we now have the framework for the new provision, modified for the cooperative fix.
Editor's Note: Tax Columnist Rod Mauszycki is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in Minneapolis, Minnesota.
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