This article addresses Section 199a of the Tax Cuts and Jobs Act (TCJA) which was passed in December 2017. For more information about other changes in the tax law please see the companion article, Financial Impact of the Tax Cuts and Jobs Act on Ag Producers.
Few tax laws get labeled by the code section that governs them, but this one seems to have no name other than Section 199a. The idea for this law was simple. Any business other than a c-corp (which just got the large flat-tax break) is now eligible for a 20% deduction of net business income.
In other words, these businesses won’t pay tax on the first 20% of their income. While this sounds great, the implementation of the thought became complicated. The original law that was passed included 10 pages of law that defined what kind of income qualified, overall income limitations, exceptions for capital gains, and at the last hour, a special provision for members of a cooperative.
One of the eliminated tax provisions was Section 199, or what we referred to as the Domestic Production Activities Deduction (DPAD). The cooperatives (as well as anyone who produced a good or service in the US) had been receiving this special deduction since 2004.
These co-ops were unhappy that the DPAD was cut, so they negotiated a special provision for their members.
This provision stated that in addition to the 20% of net income that wouldn’t be taxed, cooperative members would not pay tax on 20% of the income they receive from cooperatives. Most thought this was 20% of a patronage dividend, but the language clearly stated that “per unit retains” were included, which essentially made this a deduction of 20% of grain sales to a cooperative.
This would have virtually eliminated tax paid by most farm operations. In March they passed the “Grain Glitch Fix” to eliminate this provision, but the result was an even more complex interpretation of the law.
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The proposed regulations estimate that implementation of this piece of the law alone will take 30 minutes to 20 hours per individual/return with an average of two and a half hours. The details and specifications will likely take years to fully understand but here are some basics.
If your income is under $315,000 (or $157,500 if you’re single), the calculation will be the lesser of 20% of your qualified business income (likely Schedule F plus depreciation recapture on your asset sales) or 20% of taxable income minus capital gains.
The general assumption is that in most cases it will be the limit of taxable income that will apply more than the limit on qualified income.
|WITH 199A||WITHOUT 199A|
|½ SE TAX||$7,065||$7,065|
|ADJUSTED GROSS INCOME||$92,935||$92,935|
|FEDERAL INCOME TAX||$6,237||$7,891|
If your income is over $415,000, we need to apply a test that limits the deduction to either 50% of wages or 25% of wages plus 2.5% of your qualified investment. If your income is between $315,000 and $415,000, there is a complex phase-out formula to calculate.
The calculation will be complicated further if you sell any of your products to a cooperative. If you do, we will need to split your income and apply different rules to the percentage of net income that was sold to a cooperative. This means that income is limited to 20% of qualified income reduced by the lesser of 9% qualified income or 50% of wages, whichever is less.
Table 1 shows a simple example of a farm making $100,000 with no other income with a married-filing-jointly tax return.
In this case, it doesn’t matter whether the producer sells to a cooperative because the calculation is limited by taxable income. There are so many moving pieces to this law, it’s hard to generalize how it’s going to affect individual producers.
The proposed regulations did give us some definitions of what kind of income will qualify. In general, the following types of income should qualify:
- Farm income on Schedule F, Partnership or S-Corp
- Sale of business assets subject to depreciation recapture (most equipment but not raised breeding livestock or land)
- Self-Rentals (Rental income paid from an active trade or business with similar ownership)
- Other business income on Schedule C
Some businesses do not qualify for the deduction after income reaches the phase-out range, others, including farming, do.
If you’re still confused, join the crowd. The education process for tax professionals to understand this part of the new rules is going to be long and the rules will continue to be defined and fine-tuned well into the next year.
Just like the old DPAD rules, just about the time we fully understand the law, it changes. This law will sunset in 2025 so we are looking at eight years unless Congress acts again. The good news is that for most productions, it will result in lower federal income taxes being paid.