Pros and Cons of the Tax Law

Cooperative Sales Could Reap Tax Breaks, or Not, While C-Corps Lose Some Attraction

Chris Clayton
By  Chris Clayton , DTN Ag Policy Editor
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Some provisions in the tax law may clash for farmers. The benefits of sales to cooperatives could be lost for farmers who sell their grain through C-corps. (DTN photo illustration by Nick Scalise)

OMAHA (DTN) -- While members of Congress try to deconstruct a tax-law change that drives farm sales to cooperatives over private companies, farmers are taking advantage of the law change and wondering whether they will get to continue reaping the rewards.

Then there are the farmers who would like to take advantage of some of the new 20% tax breaks for pass-through income, but they sell their commodities through C corporations. Instead of a tax deduction, they could face higher tax rates if they do not restructure those corporations.

Leonard Schock, a grain farmer from Vida, Montana, is in both of those situations. Like a lot of farmers, he had a load of wheat at the cooperative in a deferred-sale situation until the beginning of the year. That's a pretty typical practice for farmers to defer income into January, meaning there are a lot of grain sales at that time.

"I know for our co-op, it's one of the biggest weeks of the year for checks going out," Schock said. "So there is a substantial amount of income that has already come in under this current law that is on the books right now."

In the run-up to completing the new tax law, some in Congress worked to offer a counter tax deduction for grain cooperatives. The new provision on "qualified cooperative dividends" from cooperatives was written to benefit not just any patronage dividend, but also any "per unit retain allocation." That translated into any amount paid to patrons for products sold for them. The language also broadens out further into any revenue from a farmer cooperative "that is includible in gross income." The tax break amounts to 20% of all income that comes from those dividends or sales from a farmer cooperative.

"That's the problem is it's extremely broad," said Paul Neiffer, an accountant and principal with CliftonLarsonAllen. "It's essentially any payment a cooperative gives to a farmer, including purchasing their crop."

If Congress had limited the provision strictly to patronage dividends, then it would be a much smaller issue. And after the implications were flushed out a little bit earlier this month, Sens. John Hoeven, R-N.D., and John Thune, R-S.D., began working with groups representing farmer cooperatives and grain companies to correct the language in the new law.

When Schock heard about the added benefits created under Section 199A, he thought that was going to work out to be a pretty good tax break. Then he heard some senators and groups in Washington were working to "fix" the new tax break.

"It might not be so much of an advantage," Schock said. "We're doing business and this is an extra benefit, but are they going to try to take it away from us? You can't go a month or two months from this law and then jerk the rug out and say 'Oh no, we didn't mean that,' when we have been operating under that law."

Chris Johnson, a farmer from Wahpeton, North Dakota, sells to a mix of cooperatives and grain elevators, though he noted cooperatives are more dominant in the Dakotas. Johnson said he recognizes the changes for cooperatives in the Section 199A provision shouldn't have happened in the first place.

"There is too much noise on this Section 199A," Johnson said. "They were going to fix it in some way, but we don't know how."

Neiffer said he believes any technical fix to the Section 199A language would likely be retroactive to Jan. 1 sales. Still, it is possible Congress recognizes farmers are benefiting from these early sales so the fix could have a later date to go into effect. In the meantime, Neiffer said farmers shouldn't sell to cooperatives at a lower sale price just because they assume they will make it up in lower taxes.

"They may set up a cutoff date (for cooperative sales) just to be fair, so that could happen," he said. "But I've been telling farmers to only sell to cooperatives if you get the same price you are getting everywhere else."

Even if the co-op deduction goes away, farmers are still going to qualify for the 20% of net-farm income deduction. Well, a lot of them will qualify for that 20% deduction on all qualified business income. Right now, the cooperative patron provision and the new 20% deduction on all qualified business income applies to sole proprietorships, partnerships and S corporations.

So, specifically, C corporations are excluded from reaping the rewards of those Section 199 A deductions. Like literally thousands of savvy farm operations, Schock set up C-corps that, until the new law came into effect, had lowered his taxable income on some grain sales.

The changes for C corporations -- with all C-corps now taxed at 21% -- translates into a tax increase for farmers such as Schock who set up C-corps to generate income that had been capped at the former 15% tax bracket. That essentially works out to a 47% increase in tax brackets for those farmers who created C-corps specifically to come in at the 15% bracket.

"I was visiting with my accountant the other day and was griping about that, and she said a majority of her clients that are corporations are C-corps and 85% of them try to come in around $50,000 or under to stay at that 15% bracket," Schock said.

If Congress is going to open up the new tax law for technical fixes, Schock said Congress should reestablish the 15% C-corp rate for smaller businesses.

"We're the ones carrying the burden for the big reduction," he said. "I'm not happy about that."

Johnson was visiting with his accountant over the possibility of switching to an S-corp. For the time being, he said he wants to better understand the options before jumping into an S-corp. He doesn't like the idea, however, of small businesses such as his paying the same corporate rate as global businesses.

"I really don't think it's fair I should have to pay the same rate as General Motors," Johnson said.

It may be a little surprising to some people how many C-corps out there that were not large corporations. There were thousands set up for various farm families that were not reporting a lot of income. A lot of farmers will look to convert from C-corps to S-corps.

"They are going to switch to take advantage of that 20% cooperative deduction they don't get as a C-corp," said Kristine Tidgren, assistant director of Iowa State University's Center for Agricultural Law and Taxation.

Kent Vickre, state coordinator of the Iowa Farm Business Association, said farmers around the state are already asking his staff about corporate changes.

"We've already had people filing the papers," he said. "We have seen some people doing that mainly because of the Section 199A deduction."

Farmers would have to file IRS Form 1118 to convert from a C- to an S-corp. Generally, those switches have to be done by March 15, but the IRS does grant late elections for reasonable causes. Because of the benefits of the cooperative deduction and the pass-through income deduction, Tidgren said a lot of farmers are going to want to restructure everything they do regarding taxes.

"It's kind of difficult to think of a new tax provision creating a huge incentive for people to change their business structure in this way," Tidgren said.

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Chris Clayton