Friday, June 21, 2019

Ag Cooperatives and the QBID – Initial Guidance


It has taken the IRS and the Treasury almost 18 months to issue proposed regulations on how the new Qualified Business Income Deduction (QBID) works with respect to qualified agricultural cooperatives and their patrons. For background information on the QBID see  Of course, the Congress didn’t help anything when the Tax Cuts and Jobs Act was passed by including a special deal for cooperatives that private grain elevators couldn’t avail themselves of.  That got “fixed” in late March of 2018, but by that time the air and water in D.C. had become so polluted over the cooperative issue that I was told personally by Senator Grassley not to anticipate any proposed regulations until the middle of 2019. For commentary on the “fix” see  The Senator was spot- on with that prediction. 

Now that we have the proposed regulations, this will be a topic that will be addressed at the 2019 Summer National Farm Income Tax and Estate/Business Planning Seminar in Steamboat Springs, Colorado on August 13-14.  That event is sponsored by Washburn University School of Law, the Department of Ag Econ at Kansas St. University and WealthCounsel.  You can attend either in person or online.  Registration information is available here:

A brief summary of the cooperative QBID regulations – that’s the topic of today’s post.

No Deduction for a Cooperative

Under I.R.C. §199A(a), a taxpayer is eligible for up to a 20 percent QBI deduction (QBID) attributable to qualified business income (QBI) derived from a domestic business that is other than a C corporation.  Trusts and estates are eligible for the deduction.  But, the QBID does not apply to wage income or to C corporate income.  A cooperative is deemed to be a C corporation for federal income tax purposes and, thus, cannot claim a QBID.  But, a cooperative determines its taxable income after the deduction for patronage dividend distributions and the like.  I authored a BNA Tax Management Portfolio several years ago on cooperative taxation and noted there that such distributions are not taxed at the cooperative level.  Instead, the distributions are taxed at the patron level.  All cooperatives can deduct patronage distributions; exempt cooperatives can also deduct non-patronage distributions. I.R.C. §1382(c). 

While a C corporation cannot utilize the QBID, I.R.C. §199A has a special rule for patrons that receive patronage dividends – they aren’t treated as an exclusion to the patron’s QBI.  I.R.C. §199A(c)(3)(B)(ii).  In addition, the Treasury has said that for purposes of the trade or business test of I.R.C. §162 (a pre-requisite for QBI), the income is tested at the trade or business level where the income is generated.  T.D. 9847, Feb. 12, 2019.  This all means that the QBID, if any, is at the patron level and not the cooperative level. 

Special Rule for Patrons

As noted, I.R.C. §199A has special rules for patrons of ag cooperatives.  These rules stem from the fact that farmers often do business with agricultural (or horticultural) cooperative. A farmer patron could have QBI that is not tied to patronage with a cooperative and QBI that is tied to patronage with a cooperative.  

What are “patronage dividends”?  Patronage dividends include money, property, qualified written notices of allocations, qualified per-unit retain certificates for which a cooperative receives a deduction under I.R.C. §1382(b), nonpatronage distributions paid in money, property, qualified written notices of allocation, as well as money or property paid in redemption of a nonqualified written notice of allocation for which an exempt cooperative receives a deduction under I.R.C. §1382(c)(2).  But, dividends on capital stock are not included in QBI.  Prop. Treas. Reg. §1.199A-7(c)(1). 

Under Prop. Treas. Reg. §1.199A-7(c), patronage dividends or similar payments may be included in the patron’s QBI to the extent that these payments: (i) are related to the patron’s trade or business; (ii) are qualified items of income, gain, deduction, or loss at the cooperative’s trade or business level; and (iii) are not income from a specified service trade or business (SSTB) (as defined in I.R.C. §199A(d)(2)) at the cooperative level.  But, they are only included in the patron’s income if the cooperative provides the required information to the patron concerning the payments.  Prop. Treas. Reg. §199A-7(c)(2).    

The patron’s QBID.  The amount of a patron’s deduction that can be passed through to the patron is limited to the portion of the patron’s deduction that is allowed with respect to qualified production activities income to which the qualified payments (patronage dividends and per unit retains) made to the patron are attributable.  I.R.C. §199A(g)(2)(E).  In other words, the distribution must be of tax items that are allocable to the cooperative’s trade or business on behalf of or with a patron.  The cooperative makes this determination in accordance with Treas. Reg. §1.199A-3(b). This is, essentially, the domestic production activities deduction computation of former I.R.C. §199, except that account is taken for non-patronage income not being part of the computation. 

Note.  There is a four-step process for computing the patron’s QBID:  1) separate patronage and non-patronage gross receipts (and associated deductions); 2) limit the patronage gross receipts to those that are domestic production gross receipts (likely no reduction here); 3) determine qualified production activities income from the domestic, patronage-sourced gross receipts; 4) apply a formula reduction (explained below).  Prop. Treas. Reg. §1.199A-8(b).

As noted, the farmer-patron must reduce the “patron’s QBID” by a formula that is the lesser of 9 percent of QBI that relates to qualified payments from the cooperative, or 50 percent of the patron’s W-2 wages paid that are allocable to the qualified payments from the cooperative. I.R.C. §199A(b)(7)(A)-(B).  In Notice 2019-27, 2019-16 IRB, the IRS set forth various methods for calculating W-2 wages for purposes of computing the patron’s QBID.  See also Prop. Treas. Reg. §1.199A-11.

Because the test is the “lesser of,” a patron that doesn’t pay qualified W-2 wages has no reduction.  Remember, however, under I.R.C. §199A(b)(4) and Prop. Treas. Reg. §1.199A-11(b)(1), wages paid in-kind to agricultural labor are not “qualified wages” but wages paid to children under age 18 by their parents are.  For background information on that point, see

Note.  I.R.C. §199A(b)(7) requires the formula reduction even if the cooperative doesn’t pass through any of the I.R.C. §199A(g) deduction (the deduction for a patron) to the patron for a particular tax year.  If the patron has more than a single business, QBI must be allocated among those businesses.  Treas. Reg. §1.199A-3(b)(5).  Uncertainty remains, however, as to how the formula reduction functions in the context of an aggregation election.  For example, if an aggregation election is made to aggregate rental income with income from the farming operation, must an allocation be made of a portion of the rental income as part of the formula reduction? 

The formula reduction applies to the portion of a patron’s QBI that relates to qualified payments from a cooperative.  If the patron has negative QBI that is associated with business done with the cooperative, the 9 percent amount will always be lower than the W-2 wage amount.  Based on the draft form 8995-A, the QBID is to be increased by 9 percent of the AGI amount.

An optional safe harbor allocation method exists for patrons under the applicable threshold of I.R.C. §199A(e)(2) ($160,700 single/$321,400 MFJ for 2019) to determine the reduction.  Under the safe harbor, a patron must allocate the aggregate business expenses and W-2 wages ratably between qualified payments and other gross receipts to determine QBI.  Prop. Treas. Reg. §1.199A-7(f)(2)(ii).  Thus, the amount of deductions apportioned to determine QBI allocable to qualified payments must be equal to the proportion of the total deductions that the amount of qualified payments bears to total gross receipts used to determine QBI. The same proportion applies to determine the amount of W-2 wages allocable to the portion of the trade or business that received qualified payments.    

Note. The proposed regulations attempting to illustrate the calculation only mention gross receipts from grain sales.  There is no mention of gross receipts from farm equipment, for example.  Based on the language of Prop. Treas. Reg. §1.199A-7(f)(2)(ii), gross receipts from the sale of equipment and machinery should be included in the calculation and the farmer would have to allocate gross receipts from equipment sales between patronage and non-patronage income.  Indeed, in prior years, depreciation may have been allocated between patronage and non-patronage income.   Likewise, the example doesn't address how government payments received upon sale of grain are to be allocated.

The example contained in the Proposed Regulations not only utilizes an apparently unstated “reasonable method of allocation,” but uses an allocation of W-2 wage expense that doesn’t match the total expense allocation.  That will have to be cleaned up in the final regulations.  The example, as written, does not meet the requirement of the regulations to “clearly reflect income” without an explanation of how the cost allocation has been accomplished.  A taxpayer using the approach of the example would certainly fail the requirement of the regulations upon audit.  

This all means that the patron must know the qualified payments from the cooperative that were allocable to the patron that were used in computing the deduction for the patron at the cooperative level that could be passed through to the patron.  This information is contained on Form 1099-PATR.

A higher income patron that receives patronage dividends (or similar payments) from a cooperative and is conducting a trade or business might be subject to the W-2 wages and “unadjusted basis immediately after acquisition” (UBIA) limitation.  See  for a discussion of the limitation.    In that instance, the patron is to calculate the W-2 wage and UBIA limitations without regard to the cooperative’s W-2 or UBIA amounts.  Prop. Treas. Reg. §1.199A-7(e)(2).  That means that the cooperative does not allocate its W-2 wages or UBIA to patrons. Id.  Instead, a patron allocates (by election) W-2 wages and UBIA between patronage and non-patronage income using any reasonable method based on all the facts and circumstances that clearly reflects the income and expense of each trade or business.  Prop. Treas. Reg. §1.199A-7(f)(2)(i).  An example of an allocation might be by the number of bushels of grain that the patron sells during the year to various buyers – cooperatives and non-cooperatives.  But, once an election is made with respect to an allocation approach, it applies to all subsequent years. 

The patron’s QBID that is passed through from the cooperative (which is not limited by W-2 wages at the patron level) is limited to the patron’s taxable income taking into account the non-patron QBID which is limited to 20 percent of taxable income not counting net capital gains.  Any unused patron-QBID is simply lost – there is not carryover or carryback provision that applies.

Identification by the cooperative.  A cooperative must identify the amount of a patron’s deduction that it is passing through to a patron in a notice that is mailed to the patron via Form 1099-PATR during the “applicable payment period” – no later than the 15th day of the ninth month following the close of the cooperative’s tax year.  I.R.C. §199A(g)(2)(A); Prop. Treas. Reg. §1.199A-8(d)(3); I.R.C. §1382(d)

A patron uses the information that the cooperative reports to determine the patron’s QBID.  If the information isn’t received on or before the Form 1099-PATR due date, no distributions from the cooperative will count towards the patron’s QBI if the lack of reporting occurs after June 19, 2019.  Prop. Treas. Reg. §1.199A-7(c)(3); Prop. Treas. Reg. §1.199A-7(d)(3). 

Note.  The Preamble to the proposed regulations states that these rules apply to both exempt and nonexempt cooperatives as well as patronage and nonpatronage distributions.

Is the Patron’s Business an SSTB?  The proposed regulations indicate that a patron must determine whether the trades or businesses it directly conducts are specified service trades or businesses (SSTBs).  Prop. Treas. Reg. §1.199A-7(d)(2).  Why?  Because the cooperative must report to the patron the amount of tax items from an SSTB that the cooperative directly conducts (based on the application of the gross receipts de minimis rule of Tress. Reg. §1.199A-5(c)(1)) that is used to determine if a trade or business is an SSTB.  The patron is to then determine if the distribution from the cooperative can be included in the patron’s QBI (based on the patron’s taxable income and the phase-in range and threshold that applies to an SSTB).  The cooperative must report to the patron the amount of SSTB income, gain, deduction, and loss in distributions that is qualified with respect to any SSTB directly conducted by the cooperative on an attachment to or on the Form 1099-PATR (or any successor form) that the cooperative issues to the patron, unless otherwise provided by the instructions to the Form.

Note. Again, the Preamble to the proposed regulations states that these rules apply to both exempt and nonexempt cooperatives as well as to patronage and non-patronage distributions.


Waiting well over a year for draft proposed regulations on the cooperative QBID issue has created many hassles for taxpayers, preparers and tax software companies for the 2018 tax season (which is still ongoing in many respects).  The proposed regulations can be relied upon until final regulations are published.  Written comments on the proposed regulations are due within 60 days of publication of the proposed regulations in the Federal Register – approximately August 17, 2019.  Hard copy submissions of comments can be sent to: CC:PA:LPD:PR (REG-118425-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044.

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