High on the IRS’s priority guidance plan have been regulations to help show taxpayers how to claim the 20% Qualified Business Income (QBI) deduction for passthrough entities. The latest IRS rules address the QBI deduction for cooperatives and their patrons, including agricultural and horticultural cooperatives. The IRS also released information on how cooperatives calculate W-2 wages and on the “grain glitch” fix, a 2018 revision to the tax reform law. The grain glitch was a provision in the original tax reform act that created a tax disparity between marketing products to cooperatives versus commercial operators that are non-cooperatives. Congress fixed the provision in March 2018.
Computing W-2 Wages for Cooperatives
Notice 2019-27 explains how to calculate W-2 wages for cooperatives using three different methods. The calculation is used for the special deduction allowed agricultural and horticultural cooperatives which is similar to the former domestic production activities deduction.
The write-off is calculated as 9% of the lesser of: (1) qualified production activities income for the year; or (2) the cooperative’s taxable income for the tax year. The deduction is limited to 50% of the cooperative’s yearly W-2 wages paid. The three computation methods for the W-2 wage limit that applies to cooperatives include: (1) unmodified box method; (2) modified Box 1 method; and (3) tracking wages method. The first method (the unmodified Box method) is a simplified calculation, while the second and third methods are more complex, but provide greater accuracy.
Special rules are provided for applying patronage versus non-patronage deductions. Also, statutory employee wages are not included in the calculation. The Notice allows cooperatives to use any reasonable method to calculate wages as long as it is consistently applied from one tax year to the next, is consistent with books and records, and clearly reflects wages.
Patrons Must Reduce QBI Deduction
Proposed regulations issued at the same time as the Notice describe the QBI deduction amount for cooperatives and their patrons. Specifically, the rules explain (1) how patrons of agricultural and horticultural cooperatives (“Specified Cooperatives”) calculate their QBI deduction by applying a required reduction; and (2) how cooperatives calculate and pass through the deduction. Note that the proposed rules impose significant reporting requirements on cooperatives. The proposed regulations affect cooperatives as well as patrons that are individuals, partnerships, S corporations, trusts, and estates engaged in domestic trades or businesses.
A reduction of the QBI deduction is required for patrons of Specified Cooperatives. Patrons that receive cooperative payments must reduce their QBI deduction by the lesser of 9% of the QBI allocable to those payments, or 50% of the W-2 wages paid. This reduction is required whether the Specified Cooperative passes through all, some or none of the cooperative’s deduction to the patrons in the taxable year. These payments are defined to include any amount of a patronage dividend or per-unit retain allocation from a Specified Cooperative that is attributable to the cooperative’s qualified production activities income.
Additional rules help determine domestic production gross receipts and describe how to compute costs allocable to a Specified Cooperative’s gross receipts. Finally, special provisions for expanded affiliated groups are included.
Cooperatives must provide patrons with sufficient information to determine their individual QBI deductions. To this end, a cooperative must determine whether its distributions of patronage dividends and similar payments from each business contain qualified items of income, gain, deduction, and loss. The cooperative also must determine the amount of income from specified service trade or businesses including income, gain, deductions, and losses included in its distributions, for service businesses directly conducted by the cooperative. A Specified Cooperative must report the number of distributions that are qualified payments to the eligible taxpayer. All of this information is reported to the patron on Form 1099-PATR, Taxable Distributions Received From Cooperatives or any successor 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 threshold amounts ($315,000 for joint returns and $157,500 for single taxpayers) and whether the patron reduction applies.
The 156-page set of regulations contains numerous examples of QBI calculations, including a safe harbor to keep the IRS off your back. The IRS intends to hold a public hearing on the rules at the end of Summer and could make changes before the rules are finalized. For now, taxpayers can rely on the proposed rules when navigating the special QBI rules for cooperatives.