IRS Issues Long-Awaited Proposed 199A Regulations for Cooperatives and Their Patrons
On June 18, 2019, IRS and Treasury issued proposed regulations for the application of IRC §199A to cooperatives and their patrons. These rules were a missing piece of the initial §199A regulatory package. Although the agencies published proposed §199A regulations (REG-107892-18) on August 16, 2018, and final rules (TD 9847) on February 8, 2019, the agencies delayed the issuance of cooperative-specific rules until today. IRS also today posted new questions and answers relating to patrons and cooperatives on its QBI FAQ page (see questions 34 to 47).
This post details two major sections of this new guidance: (1) rules for how patrons of cooperatives calculate their §199A QBI deduction by applying a potential reduction, and (2) how Specified Cooperatives calculate and pass through the §199A(g) deduction (the new DPAD). Both sections incorporate significant reporting requirements for cooperatives. They also contain specific requests for comments from practitioners. Future articles will look at other provisions within the proposed regulation.
Proposed §1.199A-7, Rules for Patrons of Cooperatives to Calculate 199A QBI Deduction
Section §1.199A-7 of the proposed regulations provides guidance and special rules for the application of Treas. Reg. §§1.199A-1 through 1.199A-6 (the final §199A regulations) to patrons and cooperatives. In other words, it describes how the QBI deduction applies to cooperative-related income.
QBI Deduction Not Available to C Corporations, Including Cooperatives
First, the proposed regulations reiterate that the QBI deduction is not available to C corporations, including cooperatives or their C corporation patrons. Patrons that are individuals are eligible for the deduction. This definition includes trusts and estates to the extent the deduction is taken at the trust or estate level.
When Patron Income Includes Cooperative Distributions and Non-Cooperative Income
To the extent a patron has income directly from its own a trade or business (as opposed to receiving income from a cooperative), the patron will calculate the §199A deduction under the final §199A rules (not these proposed rules). To the extent the patron receives a distribution from a cooperative, including "patronage dividends or similar payments from a cooperative," the patron follows the special rules in new Prop. Treas. Reg. §1.199A-7 to calculate the §199A deduction.
“Patronage dividends or similar payments” include money, property, qualified written notices of allocations, and qualified per-unit retain certificates for which an exempt or nonexempt Cooperative receives a deduction under section 1382(b), and non-patronage 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 section 1382(c)(2) (hereinafter collectively referred to as patronage dividends or similar payments). Note: This definition includes patronage dividends and per unit retains paid in money (PURPIM).
“Patronage dividends or similar payments” may be included in the patron’s QBI:
- To the extent that these payments are related to the patron’s trade or business,
- Are qualified items of income, gain, deduction, or loss at the Cooperative’s trade or business level,
- Are not income from a specified service trade or business at the Cooperative’s trade or business level (except as permitted by the threshold rules), and
- Provided the patron receives certain information from the Cooperative about these payments (see proposed §1.199A-7(c)(3) and (d)(3)).
Patronage dividends or similar payments are generated from the trade or business the cooperative conducts with or on behalf of the patron.
Reporting Requirement for Qualified Items of Income, Gain, Deduction, or Loss
The cooperative must determine and report to the patron whether the distribution contains qualified items of income, gain, deduction, or loss (as defined under Treas. Reg. §1.199A-3(b)). The patron must have that information to determine his or her §199A deduction. The proposed regulations require the cooperative to report this information on an attachment to or on the Form 1099-PATR (or on any successor form), unless otherwise provided by the instructions to the Form. The cooperative, for example, cannot include as qualified items those distributions flowing from trade or business income outside of the United States, or interest income not allocable to the cooperative’s trade or business.
The proposed regulations provide that if the patron does not receive this information from the cooperative on or before the due date of the form 1099-PATR, the amount of distributions from the cooperative that may be included in the patron’s QBI is presumed to be zero. This does not apply to amounts of qualified items of income, gain deduction and loss to the extent that they were not reported on the Form 1099-PATR or attachment before the publication of these proposed regulations. These reporting rules apply to exempt and nonexempt cooperatives and patronage and non-patronage distributions.
Note: The agencies are requesting comments on these reporting requirements and whether any additional information from cooperatives that make distributions to their patrons is needed for the patrons to determine their IRC § 199A(a) (QBI) deduction.
Cooperatives must determine whether any of their distributions to patrons include items of income, gain, deduction, and loss from a specified service trade or business (SSTB) directly conducted by the cooperative. If they do, the patron can treat this income as QBI only to the extent that the patron’s income is below the statutory income threshold or within the phase-in range. The cooperative can apply the gross receipts de minimis rule in §1.199A-5(c)(1) to determine if its trade or business is an SSTB.
Unlike a pass-through business, patrons of cooperatives calculate their W-2 wage and UBIA of qualified property limitations at the patron level, without any regard to the cooperative’s W-2 wages or UBIA. Consequently, the cooperative is not required to report W-2 wages or UBIA to its patrons.
SSTB Reporting Requirement
The proposed rules require the cooperative to report to the patron: (1) whether the distributions include qualified items of income, gain, deduction, and loss from a non-SSTB and (2) whether the distributions include qualified items of income, gain, deduction, and loss from an SSTB. The proposed regulations provide that if the patron does not receive this information from the cooperative on or before the due date of the form 1099-PATR, the amount of distributions from the cooperative that may be included in the patron’s QBI is presumed to be zero.
Special rule for Patrons of Specified Cooperatives – IRC § 199A(b)(7) Reduction
A patron of a Specified Cooperative that receives a qualified payment must reduce its IRC § 199A(a) QBI deduction as provided in Treas. Reg. §1.199A-1(e)(7). This reduction applies whether the cooperative passes through some, all, or none of the Specified Cooperative’s § 199A(g) (the new DPAD) to its patrons in that taxable year.
The QBI reduction equals the smaller of (1) nine percent of the QBI for that trade or business that is allocable to qualified payments from the Specified Cooperative or (2) 50 percent of patron’s W-2 wages paid that are allocable to those qualified payments.
Note: If the patron pays no wages, there is no reduction.
The proposed regulations provide that when a patron receives both qualified payments from cooperatives and other income that is not a qualified payment in its trade or business, the patron must allocate those items and related deductions using a “reasonable method based on all the facts and circumstances.” Different reasonable methods may be used for the different items and related deductions. The chosen reasonable method, however, must be consistently applied from one tax year to another and must clearly reflect the income and expenses of the business. Likewise, the overall combination of methods must be reasonably based on all the facts and circumstances, and the books and records maintained for a trade or business must be consistent with any allocations.
Note: The agencies are requesting comments as to whether a permissible “reasonable method” shall be specified in regulations or permitted to include methods based upon direct tracing, allocations based on gross income, or other methods.
A patron with taxable income under the threshold ($157,500 / $315,000 MFJ in 2018) is eligible to use a new safe harbor set forth in the proposed regulations. Under the safe harbor, the patron may allocate by ratably apportioning business expenses based on the proportion that the amount of qualified payments bears to the total gross receipts used to determine QBI. The same proportion applies to allocate the proper amount of W-2 wages to the portion of QBI comprising qualified payments (that portion for which a reduction must be calculated).
Note: The safe harbor is optional. If another “reasonable method” would produce a more accurate, beneficial result, the patron may use that method. He or she, however, must be consistent from year to year.
Proposed §1.199A-7(e) provides that in situations in which a patron conducts a trade or business that receives patronage dividends or similar payments from a cooperative, the W-2 wages and unadjusted basis immediately after acquisition (UBIA) of qualified property considered are those of the patron’s trade or business and not of the cooperative that directly conducts the trade or business from which the payments arise.
Reporting Requirement for Qualified Payments
A cooperative must report the amount of the qualified payments made to the eligible taxpayer, as defined in section 199A(g)(2)(D) on an attachment to or on form 1099-PATR (or a successor form).
The proposed regulations specify that no deductions under IRC §199A are allowed to patrons for any qualified payments that are attributable to QPAI with respect to which a deduction is allowable to the Specified Cooperative under section 199, as in effect on or before December 31, 2017, for a taxable year of the cooperative beginning before January 1, 2018.
If a patron of a cooperative cannot claim a deduction under §199A for any qualified payments described in the transition rule, the Cooperative must report this information on an attachment to or on the form 1099-PATR (or any successor form) issued by the Cooperative to the patron, unless otherwise provided by the form instructions.
Pages 74 through 77 of the proposed regulations provide helpful examples regarding the calculation of the §199A deduction for patrons of Specified Cooperatives. Example one seems to apply an unstated "reasonable" allocation method, and example five applies the safe harbor.
Proposed §1.199A-8, Deduction for Income Attributable to Domestic Production Activities of Specified Cooperatives (i.e. “New DPAD)
IRC § 199A(g) provides a deduction for Specified Cooperatives and their patrons that is similar to the old DPAD (IRC §199). This deduction is available only to Specified Cooperatives and their patrons (if the cooperative chooses to pass it through to its patrons). Specified Cooperatives are defined by the proposed regulations as cooperatives which manufacture, grow, extract or market agricultural or horticultural products. The definition of agricultural and horticultural products is extensive and will be discussed in a different article. These cooperatives can be exempt or non-exempt.
Calculating the IRC § 199A(g) Deduction
The proposed regulations then provide non-exempt Specified Cooperative with four steps to calculate the 199A(g) deduction. The rules for exempt Specified Cooperatives are beyond the scope of this article. The rules are similar to the old DPAD calculation, but the proposed rules account for the fact that non-patronage income cannot be used to calculate the 199A(g) deduction.
Step One: Split patronage and non-patronage gross receipts and related deductions (only patronage gross receipts may be used to calculate the deduction)
Step Two: Identifying Patronage DPGR (identify those patronage gross receipts that qualify as domestic production gross receipts)
Step Three: Calculate Patronage QPAI (calculating qualified production activities income from only patronage DPGR)
Step Four: Calculate Patronage Section 199A(g) Deduction (Equal to Nine Percent of the lesser of QPAI or taxable income and subject to the 50 percent W-2 Wage limitation)
Note: On June 18, 2019, IRS also issued Notice 2019-27, which provides Methods for Calculating W-2 Wages for Purposes of Section 199A(g). Proposed 1.199A-11 also provides detailed instructions for calculating and allocating W-2 wages for this purpose.
Passing the Section 199A(g) Deduction to Patrons
Once the Specified Cooperative calculates the deduction, it may pass the deduction to its “eligible patrons.” Eligible patrons are (1) patrons other than C corporations and (2) patrons that are Specified Cooperatives. Specified Cooperatives may, at their discretion, pass through all, some, or none of its patronage §199A(g) deduction to its eligible patrons.
The amount of the §199A(g) deduction that the cooperative can pass through is limited to that portion allowed with respect to the QPAI to which the qualified payments made to the eligible taxpayer are attributable.
“Qualified payment” means any amount of a patronage dividend or per-unit retain allocation, as described in §1385(a)(1) or (3) received by a patron from a Specified Cooperative that is attributable to the portion of the Specified Cooperative’s QPAI, for which the cooperative is allowed a §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 payment using the same method of accounting it uses to calculate its taxable income. These proposed rules are essentially the same as those for the DPAD calculation, with the exception of those specific provisions dealing with “eligible taxpayers.”
Reporting Requirement for Passing through the §199A(g) Deduction
If the cooperative passes the §199A(g) deduction through to its patrons, it must identify the amount of the deduction in a notice mailed to the eligible patron no later than the 15th day of the 9th month following the close of the taxable year of the Specified Cooperative. The cooperative must also report the amount of the §199A(g) deduction passed through to the eligible taxpayer on an attachment to or on the form 1099-PATR (or any successor form), unless otherwise instructed by the instructions to the form.
How Patrons Use the §199A(g) Deduction if Passed Through
Patrons to whom the specified cooperative passes the §199A(g) deduction may deduct it up to the amount of their taxable income (in the tax year the written notice is received, which is on or before the due date of the Form 1099-PATR). Taxable income for this purpose takes into account the §199A QBI deduction, but not the §199A(g) deduction. Remember that the QBI deduction is limited to 20 percent of the taxpayer’s taxable income minus net capital gain. The §199A(g) deduction passed through to patrons is not subject to the W-2 wage limitation.
Any §199A(g) deduction the eligible taxpayer cannot use is lost and cannot be carried forward or back to other taxable years.
Effective Date and Request for Comments
The proposed regulations apply to taxable years ending after the date the Treasury adopts the regulations as final, but taxpayers can rely on the proposed regulations until that date (but only if the taxpayers apply the rules in their entirety and in a consistent manner). Written (including electronic) comments and requests for a public hearing must be received by August 19, 2019.
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