IRS Issues Proposed Section 199A Regs for Cooperatives and Their Patrons

(Parker Tax Publishing June 2019)

The IRS issued proposed regulations which provide guidance to cooperatives and their patrons on calculating the deduction for qualified business income (QBI) under Code Sec. 199A, as well as guidance to specified agricultural or horticultural cooperatives (specified cooperatives) and their patrons regarding the deduction for domestic production activities under Code Sec. 199A(g). The proposed regulations also (1) provide guidance on Code Sec. 199A(b)(7), relating to the rule requiring patrons of specified cooperatives to reduce their deduction for QBI under Code Sec. 199A(a); (2) provide a single definition of patronage and nonpatronage under Code Sec. 1388; and (3) remove the final regulations, and withdraw the proposed regulations that have not been finalized, under former Code Section 199. REG-118425-18.

Background

Code Sec. 199A(a) provides taxpayers a deduction of up to 20 percent of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate, and up to 20 percent of qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income. Code Sec. 199A(b)(7) requires patrons of specified agricultural or horticultural cooperatives (specified cooperatives) to reduce their Code Sec. 199A(a) deduction if those patrons receive certain payments from such cooperatives. Section 199A(g) provides a deduction for specified cooperatives and their patrons (Code Sec. 199A(g) deduction) that is based on the former Code Section 199 deduction. Before amendments to Code Sec. 199A by the Consolidated Appropriations Act of 2018, Code Sec. 199A(g) provided a modified version of the Code Sec. 199A(a) deduction for specified cooperatives.

The IRS issued proposed and final Code Sec. 199A regulations in August of 2018 and February of 2019, respectively. However, those regulations did not address patrons' treatment of payments received from cooperatives for purposes of Code Sec. 199A(a) or the Code Sec. 199A(g) deduction for specified cooperatives, though it did restate the reduction required under Code Sec. 199A(b)(7). The preamble to the proposed regulations stated that the IRS would continue to study that area and intended to issue separate proposed regulations describing rules for applying Code Sec. 199A to specified cooperatives and their patrons. On June 18, the IRS issued those proposed regulations.

Guidance in Proposed Regulations

The IRS organized the proposed regulations into six sections: Prop. Reg. 1.199A-7 through Prop. Reg. 1.199A-12.

In Prop. Reg. Sec. 1.199A-7, the IRS describes rules for patrons of cooperatives to calculate their Code Sec. 199A(a) deduction and rules for patrons of specified cooperatives to calculate the reduction to their Code Sec. 199A(a) deduction as required by Code Sec. 199A(b)(7). Unless otherwise provided in the proposed regulations, all of the rules set forth in the final Code Sec. 199A regulations issued in February of 2019 (i.e., TD 9847) relating to the Code Sec. 199A(a) deduction apply to cooperatives and their patrons. Specified cooperatives are a subset of cooperatives; therefore, the requirements in Prop. Reg. Sec. 1.199A-7 also apply to specified cooperatives.

Prop. Reg. Sec. 1.199A-8 sets out the criteria that specified cooperatives must satisfy to qualify for the Code Sec. 199A(g) deduction, and sets forth four steps necessary to calculate this deduction. These proposed regulations provide that the Code Sec. 199A(g) deduction available to specified cooperatives and their patrons is generally computed only with respect to patronage gross receipts and related deductions. Exempt specified cooperatives (those that qualify under Code Sec. 521) may compute their Code Sec. 199A(g) deductions with respect to both patronage and nonpatronage gross receipts and related deductions.

Prop. Reg. Sec. 1.199A-9 through Prop. Reg. Sec. 1.199A-11 provide additional guidance, based on the regulations under former Code Section 199, regarding the four steps set forth in Prop. Reg. Sec. 1.199A-8. Prop. Reg. 1.199A-9 provides additional rules for determining a specified cooperative's domestic production gross receipts (DPGR).

Prop. Reg. Sec. 1.199A-10 provides additional rules for calculating costs (including cost of goods sold (COGS) and other expenses, losses, and deductions) allocable to a specified cooperative's DPGR.

In Prop. Reg. Sec. 1.199A-11, the IRS provides additional rules for determining the W-2 wage limitation in Code Sec. 199A(g)(1)(B). Prop. Reg. Sec. 1.199A-12 details rules for applying Code Sec. 199A(g) in the context of an expanded affiliated group and other special rules contained in Code Sec. 199A(g)(5) that are not otherwise addressed in the proposed regulations.

The proposed regulations also include, under Code Sec. 1388, a single definition of patronage and nonpatronage in Prop. Reg. Sec. 1.1388-1(f), which is intended to reflect the current case law under Code Sec. 1388.

While the IRS states that the proposed regulations apply to tax years ending after the date the Treasury decision adopting the regulations as final regulations is published in the Federal Register, it also provides that taxpayers may rely on the proposed regulations until that date, but only if the taxpayers apply the rules in their entirety and in a consistent manner.

For a discussion of Code Sec. 199A(g) and the rules relating to specified cooperatives, see Parker Tax ¶157,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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