W-2 methods proposed for Sec. 199A(g) deduction by agricultural co-ops

In a notice of a proposed revenue procedure (Notice 2019-27), the IRS on Tuesday provided methods of calculating W-2 wages for purposes of Sec. 199A(g)(1)(B)(i), which limits the amount of a deduction available to specified agricultural or horticultural cooperatives (specified cooperatives). The deduction is substantially similar to the domestic production activities deduction under former Sec. 199, which was repealed by the legislation that enacted Sec. 199A, known as the Tax Cuts and Jobs Act of 2017, P.L. 115-97. Proposed regulations issued on the same day provide other guidance on the deduction for cooperatives and their patrons.

The Sec. 199A(g) deduction is equal to 9% of the lesser of a specified cooperative’s (1) qualified production activities income (QPAI), or (2) its taxable income (determined under Sec. 199A(g)(1)(C)). The deduction is further limited to 50% of the specified cooperative’s W-2 wages for the tax year, which are determined similarly to W-2 wages for purposes of the qualified business income (QBI) deduction under Sec. 199A(b)(4), except that they are limited to amounts allocable to domestic production gross receipts (DPGR) for purposes of Sec. 199A(g)(3)(A) (defining QPAI).

A specified cooperative is an organization described in Secs. 1381 through 1383 engaged in the manufacturing, production, growth, or extraction in whole or in significant part of any agricultural or horticultural product, or in the marketing of such products.

The proposed revenue procedure provides three methods for calculating W-2 wages for this purpose:

1. The unmodified box method;
2. The modified box 1 method; and
3. The tracking wages method.

These are essentially the same as the three methods for calculating W-2 wages for the QBI deduction for other qualifying trades or businesses under Sec. 199A, as described in Rev. Proc. 2019-11, issued in January, only substituting “specified cooperative” for “taxpayer” (see “Qualified Business Income Deduction Regs. and Other Guidance Issued”). However, while W-2 wages for purposes of the QBI deduction are those that are properly allocable to QBI, W-2 wages for the Sec. 199A(g) specified cooperative QPAI deduction are those properly allocable to DPGR for purposes of calculating QBAI.

Under the notice, to determine W-2 wages properly allocable to DPGR, a specified cooperative may use any reasonable method that is satisfactory to the IRS, based on all the facts and circumstances, so long as it is consistently applied from one tax year to the next, is consistent with books and records maintained for that purpose, and clearly reflects the wages so allocable.

The proposed revenue procedure will apply to tax years ending after Dec. 31, 2017. The IRS is requesting comments on the proposed revenue procedure.

Proposed regulations

The IRS also issued proposed regulations on Tuesday providing further guidance to cooperatives and their patrons regarding the QBI deduction under Sec. 199A (REG-118425-18). The proposed regulations provide rules for patrons of cooperatives to calculate their Sec. 199A(a) deduction and rules for patrons of specified cooperatives to calculate the reduction to their Sec. 199A(a) deduction as required by Sec. 199A(b)(7).

The proposed regulations also set forth criteria that specified cooperatives must satisfy to qualify for the Sec. 199A(g) deduction and describe the steps necessary to calculate the deduction. Rules for calculating DPGR, for calculating costs allocable to a specified cooperative’s DPGR, and other special rules are also provided.

— Paul Bonner (Paul.Bonner@aicpa-cima.com) is a Tax Adviser senior editor.