199A Deduction (Qualified Business Income Deduction)
By Steve Peters, CPA
Rosene, Pickhinke, Peters & Co., P.C.
A major component of the Tax Cuts and Jobs Act of 2017 was the addition of the 199A deduction. The 199A deduction was put in place as the counterpart to the new lower corporate tax rates put in place with the same tax bill. Because most small businesses (including farmers) are not set up as C Corporations, those small businesses did not get the benefit of the reduction in the corporate tax rates. The 199A deduction gives those small businesses an equivalent tax deduction. As such, the 199A deduction does not apply to C corporations.
So how does the 199A deduction work? On the surface it is pretty simple and may very well be simple for many taxpayers. The 199A deduction is an additional deduction equal to 20% of a taxpayers Qualified Business Income (QBI). If QBI is $100,000, the taxpayer gets an additional deduction of $20,000 in reducing taxable income.
What is QBI?
Qualified Business Income is defined as ordinary income less ordinary deductions with respect to a qualified trade or business. The key words here are “trade or business”. This term captures many different sources of income, including farm income. However, not all farm income is considered to be trade or business income. Below we look at some common sources of farm income and determine if the 199A deduction applies.
Custom Farming – If you are the operator of a farm operation or are the land owner operating under a custom farming arrangement and reporting your income on schedule F, your farm profit is QBI. This is a pretty clear case.
Crop Share – as long as the landlord shares in enough of the expenses of the farm, a crop share arrangement will qualify as a trade or business and thus qualify as QBI. If the landlord only gets a % of the grain and does not share in expenses, they likely will NOT qualify. More clarity may be given on this arrangement when final regulations are released.
Cash Rent – Many commentators assumed that rental income would qualify for the 199A deduction; however, with the release of proposed regulations in August, the answer to that appears to be NO. The one exception for cash rent would be in situations where the land is rented to a separate operating entity owned by the same owners. In this case the cash rent can be aggregated with the operating entity. For stand-alone cash rent arrangements, the 199A deduction is out.
Sale of Farmland – capital gains are not considered trade or business income and do NOT qualify as QBI.
Sale of Farm equipment – for those operating farmers, sale of farm equipment reported on Form 4797 as ordinary income will qualify as QBI.
The 199A deduction applies to many other businesses, which we will not address here.
The level of the land owner’s personal involvement is not a factor in determining if the source of your farm income is considered to be trade or business. That is determined by “the arrangement” itself.
Many farms are set up in entities such as partnerships, S corporations and LLC’s. These are called pass-through entities, meaning the income passes through and is taxed on the individual owner’s personal return. This income also qualifies as QBI, assuming it fits one of the applicable arrangements listed above.
Grain Sold to Cooperatives
Much was made of the so called “Grain Glitch”, which related to the calculation of the 199A deduction on grain sold to cooperatives. While the intention of the bill was to give taxpayers a deduction equal to 20% of the net income of the operation, the law was poorly written and actually would have allowed for a deduction equal to 20% of the gross grain sales to a cooperative. This was not the intention of the law and would have acted to give coops an unfair advantage in the grain market, so it was fixed.
The “fix” in this situation results in your tax preparer making some additional calculations to back out the portion of the 199A deduction derived from grain sales to the cooperative and then add in the 199A deduction passed through from the cooperative relating to those same grain sales. Cooperatives will be allowed to pass through 199A deductions to its members, but the amount of those deductions are yet to be seen.
We get many questions asking whether it is better to sell grain to the cooperative or non-cooperative buyer. The answer really is …”it depends”.
If you are selling grain to a cooperative, it is best to allow your tax preparer to work through the numbers and tell you if there is a difference, as there are many factors that come into play that may differ from farm to farm.
As with many things in tax law, if your income gets too high, they start taking away or limiting deduction. The same is true with the 199A deduction. When taxable income goes over $315,000 for married taxpayers ($157,500 for all others), the 199A deduction is either phased out over the next $100,000 of income (Married) ($50,000 for others) OR is limited based on wages and cost of qualified depreciable investment property held.
Final regulations on the 199A deduction are due out later this year, but we will likely not see any major changes from the proposed regulations which have already been released.