Tax Court Case Relevant to Ag Cooperatives' New DPAD Calculation

October 23, 2019 | Kristine A. Tidgren

On October 16, 2019, the United States Tax Court issued an opinion determining the correct way for an agricultural cooperative to characterize payments made to patrons and to calculate its DPAD deduction. Although IRC § 199 (DPAD) was repealed by the Tax Cuts and Jobs Act for tax years beginning on or after January 1, 2018, the opinion remains timely and relevant. It addresses several key issues involving IRS’ proposed regulations for the § 199A(g) “new” DPAD deduction, and arrives in time to inform IRS’ work in finalizing those regulations.


Ag Processing v. Commissioner, 153 T.C. 3 (2019) arose because IRS disputed an agricultural cooperative’s calculation of its DPAD, including its impact on taxable income, for tax years 2007, 2008, and 2009. The cooperative was a non-exempt agricultural cooperative primarily engaged in processing and marketing soybeans purchased from members and nonmembers. The cooperative’s members included over 170 local farmer-owned cooperatives and several regional cooperatives. The cooperative conducted business with its members on a patronage basis, and members were eligible to share in patronage dividends paid by the cooperative. The cooperative also conducted business with nonmembers on a non-cooperative basis and nonmembers were not entitled to share in patronage dividends paid by the cooperative.

The DPAD deduction was authorized by Congress beginning in 2005. In response to DPAD, cooperatives began to question the proper way to treat payments made from a cooperative to patrons for products processed or marketed by the cooperative on their behalf. IRS issued chief counsel advise and several private letter rulings that suggested that cash payments from cooperatives to patrons for crops were per unit retains paid in money (PURPIM) for purposes of the DPAD deduction.[i] Under this guidance, cooperatives were allowed to deduct PURPIM when calculating taxable income, but were not required to reduce Qualified Production Activities Income (QPAI) by PURPIM when making the DPAD calculation. This resulted in a larger DPAD deduction that the cooperative could deduct itself or pass through to its patron members.

After the cooperative adjusted its returns in an attempt to comply with IRS guidance, the IRS challenged the cooperative’s calculation and application of DPAD for three tax years, 2007, 2008, and 2009. The dispute involved four questions, which the tax court addressed in turn:

  1. Were payments made to members by the cooperative for grain marketed by the cooperative per unit retains paid in money (PURPIM), even though they were not characterized as such in an agreement between the members and the cooperative?
  2. Must a non-exempt cooperative compute its DPAD deduction separately for patronage and non-patronage activities?
  3. If separate calculations are not required, can a cooperative use its DPAD to offset any taxable income or must the deduction be allocated between patronage and non-patronage income?
  4. Can excess DPAD create or increase a net operating loss?


IRS argued that payments made to the cooperative’s patrons were not PURPIM during years where there was no specific agreement between the cooperative and the patron stating that the cooperative would be using a PURPIM system for its payments. Because the cooperative did not have an agreement or had not revised its bylaws regarding the treatment of payments as PURPIM for all tax years at issue, IRS contended that the payments made to patrons during those years had to be treated as payments for grain, not PURPIM. As such, they would be deducted from taxable income, but not included in the DPAD calculation.

The tax court ruled in favor of the cooperative on this issue, finding that the word “agreement” in IRC § 1388(f) referred to the fixed amount of the allocation, not it its characterization for tax purposes. In other words, the agreement between the patron and the cooperative needed only make clear that the payment made to a patron for its grain was fixed without reference to the net earnings of the cooperative.  Offering a market price to a patron for marketing its grain through the cooperative established such an agreement. The court ruled, “All payments that meet the definition of PURPIMS are PURPIMs under the code.”

Application to new DPAD

This ruling addresses a question that has never been answered by the tax court: If a payment to a patron qualifies as a PURPIM under the code because it is paid to a patron in an amount not based upon earnings of the cooperative, can it be characterized as anything other than PURPIM? This court opinion says, “No.”

This ruling is applicable in interpreting Examples 1 and 2 of prop. Treas. reg. sec. 1.199A-8(e). These examples have almost identical facts, but treat a payment to a patron in Example 1 as PURPIM, but a seemingly similar payment to a patron in Example 2 as not PURPIM. The question has arisen whether the cooperative might have flexibility, based upon these examples, to characterize such payments as other than PURPIM.

2- Separate DPAD Calculation for Patronage and Non-Patronage Activities?

IRS and the cooperative disagreed over the proper way to calculate the non-exempt cooperative’s DPAD. IRS argued that the cooperative was required to calculate separate DPAD deductions for its patronage and non-patronage activities. The cooperative argued that it was allowed to aggregate its patronage and non-patronage income when calculating its DPAD deduction.

The tax court again sided with the cooperative. The court ruled that the plain language of the statute did not require a separate calculation. IRC § 199(d)(3)(A) references “the deduction” in singular form. This, the court, reasoned, implies a singular computation, even at the cooperative level. The court also found that the statute did not reference a separate calculation for patronage and non-patronage activity. Specifically, the court ruled that the code did not require separate computations of taxable income for purposes of the DPAD calculation. In fact, the court found that the code and the legislative purpose behind the code supported an aggregate computation. As such, the cooperative was not required to compute a patronage DPAD and a non-patronage DPAD.

Application to new DPAD

This ruling seems to be at odds with the proposed regulations issued by IRS in June.  Prop. Treas. reg. § 1.199A-8(c)(2) states that an exempt cooperative must calculate separate §199A(g) deductions: one for patronage activity and another for non-patronage activity.  Prop. Treas. reg. § 1.199A-8(b)(2)(ii) states that a nonexempt cooperative can use only patronage gross receipts and related deductions to calculate its section 199A(g) deduction. IRS justifies the latter position by arguing that because the cooperative is now subject to a 21 percent tax rate it cannot also get the benefit of a DPAD deduction. Congress, however, did not make these distinctions in the code. Nor does this argument find support in the legislative history. IRC § 199A(g)(1)(A), just like IRC § 199(d)(3)(A), references a singular deduction. Nothing within the code suggests a separate DPAD calculation for patronage and non-patronage activities. Nothing within the code suggests that the new DPAD cannot be deducted from non-patronage income.

3 – DPAD Allocated between Patronage and Non-Patronage Income?

The cooperative argued that once it was calculated, the DPAD could be used to reduce any taxable income, patronage or non-patronage income. Here, the tax court sided with the IRS. The court found that the code does require the separation of patronage expenses and deductions from non-patronage expenses and deductions because these expenses and deductions impact the calculation of patronage dividends. If a cooperative could shift patronage deductions to non-patronage income, for example, the court reasoned it could improperly increase the amount of patronage income available for patronage dividends.

Although a specified cooperative is not required to compute separate DPADs for patronage and non-patronage activities, the court ruled that after the DPAD is calculated, the cooperative must allocate its DPAD between patronage and non-patronage accounts.

Application to new DPAD

This ruling does not support the proposed regulations requirements that a nonexempt cooperative can use only patronage gross receipts and related deductions to calculate its section 199A(g) deduction and that an exempt cooperative must calculate two separate DPAD deductions. It does, however, support an allocation of the new DPAD deduction (once calculated) between patronage and non-patronage income.

4- Can DPAD Deduction Create or Increase an NOL?

The court also considered whether the cooperative was subject to the general rule that a DPAD deduction cannot increase or create an NOL. The cooperative argued that it was subject to an exception because it filed a consolidated return. The court ruled that there was no basis to apply an exception and that the cooperative was subject to the general rule of IRC § 172(d)(7): A DPAD cannot be used to create or increase an NOL.


This case came at the proper time to inform final IRS regulations governing the new DPAD deduction under IRC § 199A(g). We will watch to see if changes are made to the proposed regulations in response.



[i] CCA 200806011 (Oct. 22, 2007); PLR 200838011 (June 18, 2008); PLR 200843015 (July 21, 2008); PLR 200843016 (July 21, 2008); PLR 200843023 (July 24, 2008); PLR 200852022 (Sept. 17, 2008); PLR 200909016 (Nov. 24, 2008); PLR 200909020 (Nov. 26, 2008); and PLR 201219001 (Feb. 3, 2012). The taxpayer in Ag Processing received its own PLR stating that soybean payments made to its members for beans it sold on behalf of the members constituted PURPIM for purposes of calculating DPAD. PLR 117726-09 (Aug. 12, 2009).