The tax reform is a boon to farmers selling to cooperatives.

WASHINGTON — A late addition to tax reform legislation rushed through Congress in December to provide farmers relief from tax benefits that would have been lost in the new law now appears to have unforeseen consequences that could significantly disrupt commodity markets, especially grain buying.

A provision in the new tax law — Section 199A — gives farmers more favorable deductions when they sell agricultural commodities directly to cooperatives than when they sell to privately held elevators, mills, ethanol plants or other businesses. The provision evidently was inserted into the tax bill to satisfy farmers, farm groups and cooperatives who were losing a significant pass-through benefit with the removal of Section 199, known as the Domestic Production Activities Deduction. New Section 199A was intended to provide benefits similar to those gained by manufacturers in the new tax law.

Under terms of the new law, Section 199A will allow farmers to deduct up to 20% of their total sales to cooperatives, resulting in zero taxable income in some cases, but will allow them to deduct only 20% of income when they sell to privately-held or investor-owned companies, according to analysis by The Wall Street Journal, Politico, Reuters, the Renewable Fuels Association (R.F.A.) and others. Previously, cooperatives and privately-held companies were on equal footing when competing to purchase grain.

The tax legislation as written created an “insurmountable” obstacle for privately-held companies, said Richard C. Siemer, president of Siemer Milling Co., Teutopolis, Ill. “It will create a lot of disruption.”

Analysis by the R.F.A., of which many of its ethanol-producing members would be affected, suggested the legislation as written would give an advantage to cooperatives of as much as 18c per bu over privately-owned buyers.

Language for Section 199A was drafted by Senators John Hoeven of North Dakota, John Thune of South Dakota and Pat Roberts of Kansas and established a special 20% deduction for pass-through entities, which was the estimated lost benefit previously received by pass-through entities under Section 199, according to the R.F.A.’s review.

“During the negotiations and discussions concerning the formulation of the new Section 199A, it was always understood and explained that the 20% deduction for farmers selling to their cooperatives only applied to patronage dividends,” the R.F.A. said in a Jan. 10 memorandum to its board of directors. “However, the language included in the bill seems to have been drafted in a way that allows for farmers that are selling to their cooperatives to deduct the gross receipts of the sale, as opposed to only the patronage dividend. The error was likely caused by the last-minute rush to craft and include the provision, which did not allow for thorough vetting. As a result, this has led to an apparent advantage to the cooperatives in these transactions over other potential grain buyers of somewhere between 3c and 18c per bu.”  

Wheat field
A wheat farmer with $500,000 in annual grain sales and $80,000 in profit under Section 199A would have no income tax liability if selling to a cooperative.

A scenario presented by The Wall Street Journal showed that a wheat farmer with $500,000 in annual grain sales and $80,000 in profit under Section 199A would have no income tax liability if selling to a cooperative because of the 20% deduction for total sales (a deduction of $100,000) but would be liable for $64,000 in taxable income (a deduction of $16,000 based on 20% of income) if selling to any other type of grain buyer.

The tax law as it stands is seen as having a significant impact on selling agricultural commodities, depending on how aggressive cooperatives want to be, one trade source said. A lack of grain storage capacity by cooperatives will not be a mitigating factor, the source said, as the cooperative simply could buy from farmers, but direct delivery to other entities, such as flour mills, ethanol plants or other non-cooperative businesses which, in effect, would have to buy grain from the cooperative.

Press reports have indicated that some farmers already have requested that grain stored at elevators be transferred to cooperatives. There also have been reports of requests to create new cooperatives.

The R.F.A. said the writers of Section 199A, Senators Hoeven, Thune and Roberts, “have indicated that they are strongly committed to passing a fix to this problem.” But the R.F.A. added, “While there seems to be strong agreement amongst the stakeholders that changes need to be made to the new Section 199A to more accurately serve the intended purpose of the provision, it is important to note that it will be challenging to find a vehicle to include the legislative fix, or otherwise secure its passage.”

Trade sources and press reports have indicated that the new tax legislation, which included Section 199A, needed only the Republican majority of senators to be passed, but that a revision may need 60 votes, which would require bipartisan support and may be more difficult to complete.

Section 199A is set to expire in 2025 if changes are not made before then.

Work to “fix” the legislation was actively underway. The National Grain and Feed Association, which has both cooperative and independent members, in an email late Thursday, indicated progress was being made “to address the unintended consequences of Section 199A in a way that replicates the tax treatment previously available to co-op farmer members under the previous Section 199, but does so in a way that restores a level playing field and does not provide a tax-based incentive that influences farmers’ marketing decisions.”

Following meetings on Jan. 8 and 11, work to address the changes began Jan. 12, with the N.G.F.A. taking a lead role in working with the National Council of Farmer Cooperatives and others.

Major cooperatives in the agricultural sector include those handling and/or processing grains, milk, produce, sugar and other commodities. That leaves a significant part of the agricultural industry on the outside looking in, including privately-held grain millers and elevators and sugar cane refiners.