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IRS updates FAQs, QBI deduction for cooperatives and patrons

IRS updates FAQs, QBI deduction for cooperatives

The IRS this week updated a list of “frequently asked questions” (FAQs) about the qualified business income (QBI) deduction available under section 199A.

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The FAQs include discussions specifically addressing the implications of section 199A and the proposed regulations for cooperatives and their patrons:

Q12. How do cooperatives qualify for the qualified business income deduction?

A12. Cooperatives do not qualify for the QBI deduction under section 199A(a) but may be eligible to take the section 199A(g) deduction. Section 199A(g) provides a deduction for Specified Agricultural or Horticultural Cooperatives (Specified Cooperatives) and their patrons similar to the deduction under former section 199, which was known as the domestic production activities deduction. The IRS issued additional guidance for cooperatives and their patrons on June 18, 2019.

Q34. What is the purpose of the proposed regulations in §§1.199A-7 through 1.199A-12?

A34. The purpose of these proposed regulations is (1) to provide guidance to patrons of cooperatives regarding the application of the QBI deduction (See Q&A1) including the reduction of the QBI deduction that is required for patrons of Specified Agricultural and Horticultural Cooperatives (patron reduction) and (2) to provide guidance to Specified Agricultural and Horticultural Cooperatives (Specified Cooperatives) and their patrons on the computation and allowance of the deduction for income attributable to domestic production activities of Specified Cooperatives (Section 199A(g) deduction).  These proposed rules apply to taxable years ending after final regulations are published in the Federal Register.  Taxpayers, however, may rely on these proposed regulations until that date, but only if the taxpayers apply the rules in their entirety and in a consistent manner.

Q35.  I am a farmer who is a patron of a Specified Cooperative.  Could I be entitled to two deductions under section 199A?

A35.  Yes.  A farmer can have a qualified trade or business that generates a QBI deduction and could be passed through a Section 199A(g) deduction from the Specified Cooperative of which the farmer is a patron.  Regardless of whether the section 199A(g) deduction was passed through, the farmer would have to determine whether their QBI deduction is subject to the patron reduction under section 199A(b)(7).  The farmer may take any Section 199A(g) deduction passed through to the extent of their taxable income determined after their QBI deduction.

Q36.  What are Specified Cooperatives?

A36.  They are agricultural or horticultural cooperatives to which Part I of subchapter T of the Internal Revenue Code applies that are engaged (i) in the manufacturing, production, growth, or extraction (MPGE) in whole or significant part of any agricultural or horticultural product, or (ii) in the marketing of any agricultural or horticultural product that their patrons have MPGE in whole or significant part.  Specified Cooperatives include cooperatives that are considered nonexempt or exempt.  Exempt cooperatives are those farmers’ cooperatives that are qualified under section 521 of the code.   An organization will not be considered exempt, even though it operates within the provisions of sections 521 and 1381 through 1388, unless it files IRS Form 1028, Application for Recognition of Exemption Under Section 521 of the Internal Revenue Code or has previously received a ruling recognizing its exemption under section 521 of the Internal Revenue Code of 1986 or corresponding provisions of prior law.

Q37.  How do cooperatives and their patrons handle the QBI deduction?

A37.  Cooperatives are C corporations for federal income tax purposes, and therefore are not eligible for the QBI deduction.  However, patrons that are individuals and certain trusts and estates may qualify for the deduction.  See also Q&A 2.   

Patrons of cooperatives that are individuals, trusts or estates and that have QBI, qualified REIT dividends or qualified PTP income may qualify for the QBI deduction.   The rules in §§1.199A-1 through 1.199A-6 apply to all taxpayers, including patrons, eligible to take the QBI deduction.  See preceding Q&A’s for additional information on computing the QBI deduction.  To the extent a patron receives patronage dividends or similar payments from a cooperative, the patron must follow the additional special rules and clarification in proposed §1.199A-7 to calculate its QBI deduction.  Patronage dividends or similar payments from cooperatives may be included in the patron’s QBI to the extent that (i) these payments are related to the patron’s trade or business, (ii) are qualified income at the cooperative’s trade or business level, (iii) are not income from a specified service trade or business (SSTB) at the cooperative’s trade or business level (unless the patron has taxable income below the threshold amount; see Q&A5), and (iv) provided the patron receives information from the cooperative regarding whether the payments are qualified items of income. Patrons that receive qualified payments from a Specified Cooperative are required to reduce their QBI deduction as provided in section 199A(b)(7) (patron reduction).  See Chapter 12 of Publication 535 and Instructions for Form 8995-A.

Q38.  How is the patron reduction computed and what are qualified payments?

A38.  Patrons that receive qualified payments must reduce their QBI deduction by the lesser of 9% of the QBI properly allocable to the qualified payments, or 50% of the W-2 wages paid with respect to the QBI allocable to the qualified payments.  This reduction is required whether the Specified Cooperative passes through all, some, or none of the Specified Cooperative’s Section 199A(g) deduction to the patrons in that taxable year. 

Section 199A(g)(1)(E) and proposed §1.199A-8(d)(2)(ii) define qualified payments as any amount of a patronage dividend or per-unit retain allocation, as described in section 1385(a)(1) or (3) received by a patron from a Specified Cooperative that is attributable to the portion of the Specified Cooperative’s qualified production activities income (QPAI), for which the cooperative is allowed a section 199A(g) deduction.  For this purpose, patronage dividends include any advances on patronage and per-unit retain allocations include per-unit retains paid in money during the taxable year.  A Specified Cooperative calculates its qualified payments using the same method of accounting it uses to calculate its taxable income.

Q39.  What information are Cooperatives required to determine and provide to patrons for computation of the QBI deduction?

A39.  Cooperatives must provide patrons with certain information for the patron to determine its QBI deduction. The cooperative must determine whether its distributions of patronage dividends and similar payments from each trade or business that is not a SSTB contain qualified items of income, gain, deduction, and loss. The cooperative must also determine the amount of SSTB income, gain, deduction, and loss included in its distributions that is qualified with respect to any SSTB directly conducted by the cooperative. A Specified Cooperative must also report the amount of distributions that are qualified payments made to the eligible taxpayer. All of this information is reported to the patron on an attachment to or on the Form 1099-PATR, Taxable Distributions Received From Cooperatives, or any successor form, unless otherwise provided by the instructions to the Form. 

The patron then determines if any of the distributions may be included in the patron’s QBI depending on the patron’s taxable income and the statutory phase-in and threshold amounts ($315,000 in the case of joint returns and $157,500 for all other taxpayers for any taxable year beginning before 2019) and whether the patron reduction applies. 

Cooperatives should not allocate W-2 wages or unadjusted basis immediately after acquisition (UBIA) of qualified property to their patrons. For the patrons’ QBI deduction, the patrons consider the W-2 wages and UBIA of qualified property from the patrons’ trade or business from which the payments arise.

Q40.  What is the Section 199A(g) deduction? 

A40. Section 199A(g) provides a deduction for Specified Cooperatives and their patrons similar to the deduction under former section 199, which was known as the domestic production activities deduction. Section 199A(g) allows a deduction for income attributable to domestic production activities of Specified Cooperatives. The deduction allowed is equal to 9 percent of the lesser of (i) the qualified production activities income (QPAI) or (ii) the taxable income of the Specified Cooperative for the taxable year. The deduction is further limited to 50 percent of the W-2 wages of the Specified Cooperative for the taxable year that are properly allocable. Calculating the deduction is further explained in Q&As below.

Q41.  How do Specified Cooperatives and their patrons handle the Section 199A(g) deduction?

A41.  Only a Specified Cooperative may calculate the Section 199A(g) deduction.  A Specified Cooperative may pass all, some, or none of the Section 199A(g) deduction to patrons that are eligible to take the deduction (this does not include a patron that is C corporation, unless that patron is a Specified Cooperative).  The Specified Cooperative will reduce its deduction under section 1382 by the amount of the Section 199A(g) deduction that was passed through.

If a Specified Cooperative passes any of the Section 199A(g) deduction to a patron that is eligible, that patron is allowed to deduct the amount so long as the deduction does not exceed the patron’s taxable income (after taking into account any QBI deduction allowed to the patron). 

Q42.  How do nonexempt Specified Cooperatives compute the Section 199A(g) deduction?

A42. Proposed §1.199A-8 sets forth four steps to determine the amount of a nonexempt Specified Cooperative’s Section 199A(g) deduction;

1.      Patronage/Nonpatronage Split – Identify and separate the gross receipts and related deductions that are from patronage sources and from nonpatronage sources.  Nonexempt Specified Cooperatives may use only patronage gross receipts and related deductions to calculate domestic production gross receipts (DPGR), QPAI, taxable income, and the W-2 wage limitation.

2.      Identify Patronage DPGR – Nonexempt Specified Cooperatives only consider gross receipts from patronage sources when identifying DPGR from the disposition of agricultural or horticultural products.  DPGR are gross receipts of the taxpayer that are derived from any lease, rental, license, sale, exchange, or other disposition of any agricultural or horticultural product which was MPGE by the taxpayer.  Such term shall not include gross receipts which are derived from the disposition of land or services.  Proposed §1.199A-9 contains additional information on DPGR.

3.     Calculating Patronage QPAI – Nonexempt Specified Cooperatives must determine cost of goods sold (COGS) and other expenses, losses, or deductions that are allocable to patronage DPGR.  Proposed §1.199A-10 contains additional information on making this determination.

4.      Calculating Patronage Section 199A(g) Deduction – A nonexempt Specified Cooperative’s Section 199A(g) deduction is equal to 9% of the lesser of QPAI or taxable income from patronage sources, and is subject to a 50% W-2 wage limitation.  A patronage Section 199A(g) deduction may only be used to reduce patronage taxable income.  Proposed §1.199A-11 contains additional information on the W-2 wage limitation.

Q43.  How do exempt Specified Cooperatives compute the Section 199A(g) deduction?

A43. Exempt Specified Cooperatives calculate two separate Section 199A(g) deductions, one based on gross receipts and related deductions from patronage sources, and one based on gross receipts and related deductions from nonpatronage sources.  Proposed §1.199A-8 requires exempt Specified Cooperatives to perform steps two through four twice, first using only its patronage gross receipts and related deductions and second using only its nonpatronage gross receipts and related deductions.  An exempt Specified Cooperative cannot combine, merge, or net patronage and nonpatronage items at any step in determining its patronage Section 199A(g) deduction and its nonpatronage Section 199A(g) deduction.  Exempt Specified Cooperatives may only use the patronage Section 199A(g) deduction to reduce patronage taxable income.

Q44.  How does a Specified Cooperative pass through a Section 199A(g) deduction to its patrons?

A44.  Specified Cooperatives may pass through all, some, or none of their allowable Section 199A(g) deduction to patrons who are eligible taxpayers as defined in section 199A(g)(2)(D), that is, (i) a patron, that is not a C corporation, or (ii) a patron that is a Specified Cooperative.  A Specified Cooperative must notify each of its patrons of the amount of Section 199A(g) deduction being passed to them in a written notice mailed to the patron during the payment period described in section 1382(d) and also include any amount passed through in such written notice on the Form 1099-PATR issued to its patrons.  The amount of the Section 199A(g) deduction that a Specified Cooperative can pass through to an eligible taxpayer is limited to the portion of the Section 199A(g) deduction that is allowed with respect to the QPAI to which the qualified payments made to the patron are attributable.  The Specified Cooperative will reduce its deduction under section 1382 by the amount of the Section 199A(g) deduction that was passed through.

Individual patrons that receive a written notice from a Specified Cooperative allocating a Section 199A(g) deduction may take the deduction to the extent of their taxable income determined after their QBI deduction.  A Section 199A(g) deduction that can’t be used in the year it is received is lost.  A Specified Cooperative that receives a Section 199A(g) deduction as an eligible taxpayer can take the deduction only against patronage gross income and related deductions, or can pass on the deduction to its patrons that are eligible taxpayers.

Q45.  Can an exempt Specified Cooperative pass through its nonpatronage Section 199A(g) deduction?

A45.  No.  Exempt Specified Cooperatives are not allowed to pass through any of the section 199A(g) deduction attributable to nonpatronage activities because no QPAI is attributable to any qualified payments.

Q46. What if a Specified Cooperative is a partner in a partnership?

A46. The proposed rules provide that the partnership must separately identify and report on the Schedule K-1 to the Form 1065, U.S. Return of Partnership Income, issued to a Specified Cooperative partner the Specified Cooperative’s allocable share of gross receipts and related deductions.  This allows the Specified Cooperative partner to include the partnership items when applying the four steps in proposed §1.199A-8 required to calculate its Section 199A(g) deduction (as described in Q&A42).  For example, when applying the four steps, a Specified Cooperative determines the amount of gross receipts from the partnership that are patronage and that qualify as DPGR from the disposition of agricultural or horticultural products. 

Q47. What is the definition of patronage and nonpatronage?

A47. Proposed §1.1388-1(f) sets forth a definition of patronage and nonpatronage that is consistent with the current state of the law. Whether an item of income or deduction is patronage or nonpatronage sourced is determined by applying the directly related use test.  The directly related use test provides that if the income or deduction is produced by a transaction that actually facilitates the accomplishment of the cooperative’s marketing, purchasing, or services activities, the income or deduction is from patronage sources.  However, if the transaction producing the income or deduction does not actually facilitate the accomplishment of these activities but merely enhances the overall profitability of the cooperative, being merely incidental to the association’s cooperative operation, the income or deduction is from nonpatronage sources.  Patronage and nonpatronage income or deductions cannot be netted unless otherwise permitted by the Internal Revenue Code or regulations thereunder, or guidance published in the Internal Revenue Bulletin.

 

For more information, contact KPMG’s National Director of Cooperative Tax Services:

David Antoni | +1 (267) 256-1627 | dantoni@kpmg.com

Or Associate National Director of KPMG’s Cooperative Tax Services:

Brett Huston | +1 (916) 554-1654 | bhuston@kpmg.com

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