As promised in last month’s posting, this post will cover Section 199A and its impact to farmers. So what is the deduction that will show up on 2018 tax returns for the first time?
At its simplest, it is a 20 percent deduction on qualified business income (known as “QBI”). However, if it were that simple we would not have needed almost 200 pages of proposed regulations! Mechanically, this 20 percent deduction on QBI is limited to 20 percent of net income minus capital gains. Expressed as a formula it would appear as follows:
199A Deduction is equal to the lesser of:
- 20% of QBI1 OR
- 20% multiplied by (taxable income minus net capital gains)
The good news for those married taxpayers who are under $315,000 of taxable income (or $157,500 single), the more complicated limitations, relating to wages and tax basis, do not apply. We will tackle these limitations in future posts. The examples below illustrate how the deduction is computed for three farm scenarios: a non-dairy farm, a dairy farm that is not a member of a cooperative and a dairy farm that belongs to a cooperative.
Example: Non-Dairy Farm
Example: Dairy Farm (Non-Cooperative)
For farmers that are part of a cooperative, there is an added limitation on the Section 199A Deduction. Once a farmer has determined the 199A deduction (part 1 of the formula above), it must be reduced by the lesser of:
- 9 percent of the QBI (allocated to the cooperative) OR
- 50 percent of the wages (allocated to the cooperative)
The reason for this limitation is to not allow farmers who receive 199A from the cooperative to “double dip” since they are being given a 199A deduction that will flow through to their individual returns.
Example: Dairy Farm (Cooperative)
The dairy farm that sells to a cooperative is in a much better spot relating to Section 199A for two reasons. First, while the individual 199A calculation is still zero, there is a $3,000 flow through 199A coming to Mr. and Mrs. Farmer from the cooperative. Second, this 199A deduction coming through from the cooperative will be able to offset capital gains income (i.e. raised cow sales).
The examples above illustrate the very broad workings of Section 199A. As you can see, there are differences in the calculations based on the type of farm and cooperative status. Additionally, many other Section 199A considerations will require careful tax planning this year.
We have not even scratched the surface yet with questions such as:
- What is qualified business income?
- How are farm rental arrangements treated?
- Can we aggregate our businesses for the calculation?
All of these and more will be explored in future posts. Stay tuned!
1 There is another technical part to this deduction that will be ignored since it does not apply to most farmers. That portion of the deduction has to do with Real Estate Investment Trusts (REIT) and Publicly Traded Partnerships(PTP). In those cases the formula would be 20% of QBI +20 percent of qualified REIT dividends and PTP income.)