Authored by Eric Kroll and Tara Guler
The Tax Cuts and Jobs Act (the Act) signed on Dec. 22, 2017 made the most comprehensive changes to federal tax law since 1986. One of the key components of the legislation is the reduction in the corporate tax rate to 21 percent. Congress also wanted businesses operating as sole proprietorships, partnerships, LLCs, S corporations and cooperatives to benefit from lower tax rates on business income as well. As a result, a new deduction was added for taxpayers with income from certain pass-through entities. As cooperatives are taxed differently than other pass-through entities, like partnerships and S corporations, a deduction was added for both cooperatives and their members under section 199A. Under section 199A, horticultural and agricultural cooperatives will be allowed a deduction of 20 percent of gross income less cooperative dividends paid during the taxable year. The deduction will generally be limited to the greater of 50 percent of W-2 wages, or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of qualified property.
At the member level, members of cooperatives will receive a 20 percent deduction of the aggregate amount of qualified cooperative dividends for the taxable year, limited only by taxable income (less capital gains). Qualified cooperative dividends include patronage dividends and per unit retain allocations paid in money or certificates. Farmers who sell to non-cooperatives will still receive a deduction under section 199A, however this deduction is 20 percent of qualified business income and is also limited to 20 percent of taxable income (less capital gains). Please see the link below for a detailed explanation of the deduction under the new bill.
The individual deduction described above has generated significant controversy since the bill has been signed into law. Under the way in which section 199A is written, it is clear that cooperative members selling their commodities to a cooperative are receiving a more favorable deduction than those who sell to non-cooperatives. The two biggest items creating this favorable treatment are 1) the cooperative deduction being a deduction from gross receipts from the cooperative (as opposed to the business income), and 2) the cooperative deduction being limited only by taxable income (as opposed to 20 percent of taxable income).
Senators Thune and Hoeven, sponsors of the cooperative provisions in the new bill, have acknowledged the consequences of this provision and have stated that there was no intent to “unfairly tip the scales in favor of marketing to one type of business entity or another.”1 They announced that Congress would be moving forward to correct the disparity, although it is unclear in what manner this will be done. The most likely strategy is to attach a fix to another bill (budget, transportation, etc…), which would still need to be negotiated. Although not as likely, technical corrections to the bill could be proposed on this topic, but doing this would open the entire tax bill for other potential amendments.
Uncertainty surrounding potential fixes and risk of business loss has pushed many non-cooperative entities to consider forming a cooperative for purchasing farmer commodities. Baker Tilly is positioned to help clients decide if forming a cooperative is the right decision. Professional legal assistance is imperative due to the unique nature of cooperative law and the taxation of cooperatives. Items to consider include (but are not limited to) cost of formation, proper classification distinction and structure of bylaws, accurate marketing agreements between the cooperative and its members, equity stake with membership and ongoing maintenance after formation. Common maintenance items are issuance of patronage checks, maintenance of equity transactions, conducting board meetings and filing cooperative tax returns.
Any clients who have questions on section 199A or would like to discuss cooperative formation should contact a member of the Baker Tilly cooperative team.
1 Parker, Mario and Sahil Kapur. Congress May Fix Unintended Tax Edge for Farm Co-Ops Over Cargill. Jan. 11, 2018; Bloomberg: https://www.bloomberg.com/news/articles/2018-01-11/congress-may-fix-tax-tweak-giving-farm-co-ops-edge-over-cargill
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.