A last-minute provision added to the new Tax Cuts and Jobs Act may have a substantial and unintended impact on the agriculture industry. The provision, known as Section 199a, gives an unexpected tax break to farmers who sell their crops to cooperatives rather than non-cooperative companies, such as privately-owned grain elevators. Update: The 199a issue has been changed with legislation passed March 23, 2018.
Agriculture cooperatives are typically owned by farmers and offer support with selling crops, obtaining supplies and various other agricultural services. As owners, members control the activities of the cooperative through a governing board and through voting at membership meetings. Non-cooperative purchasers of agricultural products are now concerned the new tax law has given cooperatives a significant advantage that may drastically change who farmers sell their agricultural products to in the future.
The Section 199a provision was added to the tax bill during the final days of negotiation, after the initial tax rewrite did not include a former deduction that benefited cooperatives under the old tax law. However, it turns out the final language of the adopted provision now gives farmers who sell to cooperatives tax incentives that go much further than the old tax law did. As a result, privately held companies that purchase agricultural products may find that if the law is not changed, they may struggle to purchase their usual supply of crops, as the new tax benefits increasingly steer farmers to sell their grain to cooperatives.
Under the Section 199a provision, farmers may now deduct 20 percent of their gross sales to cooperatives, but only 20 percent of their net income if they sell to non-cooperative companies. The following example from The Wall Street Journal demonstrates the vast implications of the new tax benefit:
“[Consider] a wheat farmer with $500,000 in annual grain sales and $80,000 in profit. A farmer selling grain to a cooperative could deduct 20 percent of sales, wiping out the entire income-tax liability. By contrast, if the farmer sells grain to an independent grain operator, the farmer’s deduction would be limited to 20 percent of the profit, or $16,000, leaving that farmer with up to $64,000 in taxable income.”
Into the Unknown
While the Tax Cuts and Jobs Act provides farmers a clear tax advantage for selling grain and other agricultural products to a cooperative instead of an independent purchaser, farmers will still need to consider price differences proposed by cooperatives against other buyers. They will also need to continue weighing cost differences for related services such as transportation, drying and storage. Though the actual impact of the new tax law is still unknown, complaints have already been levied that it unfairly favors cooperatives over private companies. On the other hand, supporters of Section 199a see the provision as a fair deal for farmers and cooperatives.
It is unknown how long the Section 199a provision will remain in its current form, as lawmakers have been clear they did not intend to give a competitive advantage to cooperatives. Some members of Congress have even indicated they are diligently working to find a quick solution. A fix could come in the form of a technical corrections bill or a change attached to the next budget bill. Any solution, however, will likely require bipartisan support—since attaching a fix to any must-pass legislation will likely require 60 votes to pass the Senate. Further, those that see the Section 199a provision as a fair deal for farmers and cooperatives have expressed that Congress should avoid any action that would raise taxes on farmers or negatively impact the viability of cooperatives. Supporters of the provision have also pointed out that corporations got a permanent tax break in the new tax law, and if the Section 199a provision is scaled back before it expires in 2025, cooperatives will be at a disadvantage.
So long as Section 199a remains unchanged, farmers will likely look to make the law work for them by selling their crops to cooperatives, rather than private companies, in order to maximize their bottom lines. As a result, independently held agricultural companies are forming cooperatives to ensure they are able to maintain their usual supply of agricultural products and to avoid paying more to farmers commanding higher prices from privately held companies to offset the tax difference. Forming a cooperative can be a viable solution for private companies, even if the provision sending farmers to cooperatives is rolled back, since the impact of the Section 199a provision may linger past any remedy offered by Congress. iBi
Logan Block is an associate attorney with Quinn, Johnston, Henderson, Pretorius, and Cerulo.