Cooperatives Council Finds Fault With Proposed Passthrough Regs

Proposed Treasury Regulations under Section 199A(g) Relating to the Treatment of Farmer Cooperatives and their Patrons

NCFC Position: In implementing new regulations under Section 199A(g), the IRS and U.S. Treasury should follow the clear language and intent of the law passed by Congress and replicate how the former Section 199 deduction (repealed in 2017) applied to farmer co-ops and the farmer-members.

Background: In the 2017 tax bill, Congress mistakenly created a “grain glitch” that created new incentives for farmers to transact with co-ops over private companies. Co-ops negotiated in good faith with private companies to restore the competitive balance and agreed to a fix in a 2018 budget bill.

IRS & Treasury are now proposing regulations that would undo this compromise by limiting the co-op deduction to patronage income only, even though under old Section 199, co-ops claimed a deduction for domestic agricultural income from both patronage and nonpatronage activities. To limit this now (despite specific language in the 2018 law directing Treasury to treat the new law just as it was under old Section 199) would be a significant tax increase on farmer co-ops and their farmer members.

There is no authority in the statute or legislative history for Treasury and IRS to make this limitation! There is no reference anywhere in section 199A(g) to “patronage” or “nonpatronage.” Section 199A(g) provides that the deduction is available for a taxpayer that is a specified agricultural or horticultural cooperative with respect to income from certain qualified activities. It does not provide that it is only available for the qualified patronage activities of a specified cooperative.

There is no indication in the legislative history that a specified cooperative must make any of the allocations required to separate patronage from nonpatronage activity and treat each part differently. Congress limited the section 199A(g) deduction in certain areas. If it wanted to do so with respect to nonpatronage activities, it would have done so.

The proposed regulations are contrary to regulatory authority! Section 199A(g), as amended, was intended to replicate former section 199. This is clear from the legislative history. Moreover, section 199A(g)(6) provides that any Treasury regulations “are to be based on the regulations applicable to cooperatives and their patrons under section 199 (as in effect before its repeal).”

Nonpatronage activities of cooperatives qualified for the former section 199 deduction since these activities support the co-op's mission and benefit the co-op's farmer-members. Under section 199, cooperatives calculated a single section 199 deduction based on combined income from both patronage and nonpatronage activity. This treatment was confirmed by a recent Tax Court decision (Ag Processing, Inc., Doc. No. 23479-14, 10/16/19). Thus, the nonpatronage limitation in the proposed regulations is directly contrary to the direction Congress provided to Treasury and the IRS to model the application of section 199A(g) after former section 199.

The rationales given by Treasury and IRS for not following the legislative language and Congress's intent are weak. The preamble to the proposed regulations provides three reasons for the nonpatronage limitation. None are compelling.

Structure of section 199A. — The preamble provides that the nonpatronage limitation “is consistent with the structure and intent of section 199A.” As indicated above, the intent of the special rules for cooperatives and their patrons is to replicate former section 199. The nonpatronage limitation fails to do so.

Further, one does not need to look to the “structure” of section 199A to determine the application of the special rules under section 199A(g). The words of section 199A(g) are clear enough on their own. Moreover, section 199A(g) does not neatly fit into the overall structure of section 199A. Section 199A was created in 2017; the section 199A(g) rules were enacted in 2018. Section 199A applies to individuals; section 199A(g) in 2018 applies only to agricultural cooperatives, which are corporate entities. The deductions under sections 199A and 199A(g) are determined using different bases, rates and limitations. Section 199A(g) does not fit into the structure of section 199A. It is wholly different.

Corporate rate cut. — The preamble then provides that nonpatronage income of a farmer cooperative “receives an alternate benefit” of the section 11 rate reduction. There is nothing “alternative” about the corporate rate reduction. Farmer cooperatives do not elect between the rate reduction and the section 199A(g) deduction. The section 199A(g) deduction applies to all qualified activities of the cooperative (whether derived from patronage or nonpatronage sources). Similarly, the corporate tax rate applies to all taxable income of the cooperative (whether derived from patronage or nonpatronage sources). There is no conditional relationship between the section 11 rate and the section 199A(g) deduction. A farmer cooperative is not two entities — a patronage entity and a nonpatronage entity. It is a single entity with a single tax base.

Congress was well aware that cooperatives are subject to the corporate tax rate and could claim the section 199 deduction for nonpatronage activity under prior law when it enacted section 199A(g). It chose not to limit the deduction to only patronage activity.

Competitiveness. — The preamble concludes that the nonpatronage limitation is necessary to support the competitiveness aspects underlying the enactment of section 199A(g). It is true that Congress enacted section 199A(g) in 2018 to restore a perceived imbalance created by the Tax Cuts and Jobs Act of 2017. The 2017 Act treated farmers that transacted with cooperatives more favorably than farmers that transacted with non-cooperatives. That is, the concern was with respect to patronage activity. The concern and the Congressional response had nothing to do with nonpatronage activity. Non-cooperatives never complained about the nonpatronage activity of cooperatives, and the issue was never discussed in negotiations between the parties or the Hill staff. It should not be an issue now, after the fact. Had the farmer cooperatives understood that they were losing the section 199 benefit on nonpatronage activity, they would not have agreed to the 2018 legislative compromise.