The following commentary does not necessarily reflect the views of AgWeb or Farm Journal Media. The opinions expressed below are the author's own.
The following commentary does not necessarily reflect the views of AgWeb or Farm Journal Media. The opinions expressed below are the author's own.
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Now that the dust has settled on the final Section 199A rules, it is time to discuss whether farmers who deal with some type of packing warehouse should either join or create some type of cooperative. Washington state is the number one grower of apples and sweet cherries along with being a major producer of other fruits and vegetables. Most of these crops are picked in the field and then a local warehouse will sort, pack and sell the fruit or vegetable for the farmer. Many growers are members of a cooperative and historically have received a DPAD from the cooperative which is some cases exceeds 5%-10% of gross payments from the cooperative.
However, the substantial majority of growers in this state and likely many other states around the country do not sell their crop to a cooperative to be packed and sold. Rather, they sell it to private warehouses. Due to the final Section 199A rules, you may want to consider either joining a cooperative or perhaps finding other like-minded growers to create a cooperative (assuming you have enough revenues). There are many requirements to create a cooperative that are beyond the scope of this post, but I am going to show you how the income tax deduction can change by being a member of a "packing" cooperative. In many cases, it requires less than 5 members to become a cooperative.
Let's assume that you are a apple grower in Washington State and in a typical year you receive $5 million of net payments from your local warehouse. You net about 10% of your farm income which is also your taxable income. Under Section 199A, your net deduction for the year is $100,000 ($500,000 times 20% limited to $500,000 times 20%). Now, let's assume that you join and/or create a cooperative. This cooperative will pass-out to you a DPAD equal to the lessor of 9% of its taxable income or 50% of wages that it pays. In most cases the DPAD is almost always equal to 50% of wages paid. If wages are 10% of the payments to you as a grower, then your DPAD will equal 5% of your payments or $250,000. If wages are 20% of payments to you, then the DPAD will equal 10% or $500,000. It appears that in most cases, wages paid by a packing cooperative will generally be close to this range.
Since the DPAD is passed out to you, the only limit on the deduction is your taxable income. In the lower wage cooperative, the net deduction is $250,000 plus $55,000 (I am going to assume the worst case for the remaining Section 199A deduction at 11% of net farm income and assume no wage limit for you) for a total deduction of $305,000. In the high wage cooperative, your deduction is $500,000 but it will be limited to $445,000 ($500,000-$55,000) bringing your taxable income to zero . As you can see, belonging to a cooperative increases your deduction by a minimum of $205,000 up to $400,000.
If your net farm income is closer to 20% of gross payments, then the regular Section 199A deduction will increase to $200,000. If you belong to a cooperative, the DPAD does not change, however the extra Section 199A deduction will be $110,000 (minimum amount). Therefore, dealing with a cooperative in this situation increases your net deduction by $160,000 to $410,000.
No matter how you increase or decrease your net farm income, the total Section 199A deduction from a cooperative with higher wages will be more than you would get by just selling to a private warehouse. If you are a smaller grower, then joining a warehouse may make some sense. If you are a larger grower, setting up your own cooperative in conjunction with other like-minded growers may save you taxes.
Grain marketing cooperatives historically have much lower wages. Most of our other posts have highlighted where the Section 199A deduction under the new law can either be higher or lower for farmers selling to a cooperative versus a private. However, when dealing with packing warehouses, your net Section 199A deduction will almost always be higher than selling to a private the difference can be substantial.
One caveat - this deduction is scheduled to expire after 2025. Setting up a cooperative and managing it can be expensive. You must discuss this with your tax advisor.
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