By now, most taxpayers are aware of the sweeping changes made with the Tax Cuts and Jobs Act (TCJA) late last year. Within the law were some drastic changes in the way that the income of farmers – especially those who are members of cooperatives – are taxed. When the law first took effect, there appeared to be an unintentional “grain glitch” that gave cooperatives a competitive advantage over corporate-owned businesses.
Initially, farmers were to be granted a 20 percent deduction on gross sales with a cooperative, while the deduction for doing business with a corporate-owned company was calculated on 20 percent of net income. To simplify, assume a farmer sold $1,000,000 of grain to an elevator, and had $800,000 of expenses, resulting in $200,000 of net income.
- The deduction for selling that grain to a cooperative would result in a deduction of $200,000 (20% x $1,000,000), resulting in zero taxable income.
- The deduction for selling that grain to a corporate company would result in a deduction of $40,000 (20% x $200,000), resulting in a profit of $160,000 that would be taxed.
It is easy to see why it became such a priority to level the field so that there was not such a large variance in the tax effect of doing business with either type of entity. In late March, Congress passed an amendment to agricultural cooperative taxation, with the changes retroactive to January 1, 2018.
These changes have resulted in a more level playing field. Under the new law, cooperatives can pass deductions through to the farmers (much like in the past, when cooperatives would pass Domestic Production Activities Deduction [DPAD] amounts via 1099-PATR to their patrons). This pass-through deduction, coupled with other changes stemming from the TCJA, can result in a powerful planning mechanism for taxpayers. In addition to the possible 20 percent business income deduction for pass-through entities enacted by the passing of the TCJA, certain taxpayers can receive an additional 9 percent deduction via the cooperative.
The calculations for determining the total deduction can be very complex, so it is vital to align yourself with an accounting firm that can help you properly calculate the tax affects. It is especially important to do tax planning before year-end to reduce costly equipment purchases or other inputs that may be avoidable.