Proposed regulations implement Section 199A ‘grain glitch’ fix

Tax Hot Topics newsletter The IRS issued proposed regulations (REG-118425-18) on June 18 that provide guidance to cooperatives, specified agricultural and horticultural cooperatives (referred to as specified cooperatives), and their patrons regarding the deduction for qualified business income (QBI) under Section 199A(a), the reduction to the QBI deduction under Section 199A(b)(7), and the deduction for domestic production activities under Section 199A(g). Concurrent with the proposed regulations, the IRS issued Notice 2019-27 which proposes a draft revenue procedure providing three proposed methods that specified cooperatives may use for calculating W-2 wages for purposes of these rules.

The proposed regulations generally provide patrons of cooperatives and specified cooperatives guidance regarding the application of the QBI deduction under Section 199A(a). While income generated from an ownership in a C Corporation (cooperatives are classified as C corporations for U.S. federal income tax purposes) is not considered QBI, Section 199A provides a special rule for eligible patrons receiving patronage dividends from a cooperative. To the extent an eligible patron receives patronage dividends or similar payments from a cooperative, such payments may be included in the patron’s QBI. As such, the proposed regulations require cooperatives to determine and report to their patrons which payments are considered qualified items of income, gain, deduction, or loss (i.e., effectively connected with the conduct of the cooperative’s trade or business within the United States and included or allowed in determining taxable income for the year) from a qualified trade and business or a so-called specified service trade or business (SSTB). Unlike Section 199A(a), which is generally available to individual patrons of any type of cooperatives, Sections 199A(b)(7) and 199A(g) apply only to specified cooperatives and their patrons. The proposed regulations provide that specified cooperatives and their patrons must meet a set of requirements, that if satisfied, qualify the specified cooperative for up to a 9% deduction under Section 199A(g) for income attributable to its domestic production activities. In order to calculate the deduction, the proposed regulations provide a four-step approach that is largely leveraged off of previous guidance from the domestic production activities deduction under former Section 199.

Because patrons of specified cooperative may be eligible to take both a Section 199A(a) and Section 199(g) deduction, Section 199A(b)(7) provides that a patron of a specified cooperative must reduce its QBI deduction by the lesser of (i) 9% of the QBI from such trade or business that is properly allocable to the qualified payment from the specified cooperative or (ii) 50% of the patron’s W-2 wages properly allocable to such trade or business. The proposed regulations provide a safe harbor for determining the Section 199A(b)(7) reduction for patrons with taxable income not exceeding $315,000 (for joint filers) or $157,500 (for all other filers), who are generally not subject to the SSTB or W-2 and UBIA limitations.

The proposed regulations also include reporting requirements to address the special rule that prevents qualified payments from a Specified Cooperative that remain subject to former Section 199 from being eligible for a Section 199A(a) deduction to its patrons.

These provisions are proposed to be effective for taxable years ending after the date that the final regulations adopting the proposed regulations are published. However, taxpayers may rely upon the proposed regulations, in their entirety, until that date.

Grace Kim
Principal, Partnerships
Washington National Tax Office 
T +1 202 521 1590

Jose Carrasco
Senior Manager, Partnerships
Washington National Tax Office 
T +1 202 521 1552

Ryan Nodal
Washington National Tax Office 
T +1 803 231 3020

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