PL 115-141: The Tax Correction for the Grain Glitch

On March 23, 2018, Public Law 115-141, the Consolidated Appropriations Act, 2018, was signed into law. While this omnibus spending bill addressed funding for the federal government, its most enduring legacy for tax policy was a technical correction to the Tax Cuts and Jobs Act (TCJA). This correction fixed a flaw known as the “grain glitch,” which created unintended consequences in the agricultural sector and required swift legislative action. This article will cover the problem, the solution, and the reporting duties for affected taxpayers.

The Tax Problem Before the Fix

The Tax Cuts and Jobs Act of 2017 introduced a new tax benefit for pass-through businesses, including sole proprietorships, partnerships, and S corporations. This benefit, codified in Section 199A of the Internal Revenue Code, is the Qualified Business Income (QBI) deduction. It allows owners of these businesses to deduct up to 20% of their qualified business income from their individual income tax returns, lowering their overall tax liability.

A problem emerged from the original TCJA language concerning how this deduction applied to farmers and agricultural cooperatives. The law allowed a farmer who sold commodities to an agricultural cooperative to calculate their 20% deduction based on their gross sales to the co-op. In contrast, a farmer who sold the same products to a private company could only calculate their 20% deduction based on their net income from those sales.

This created an imbalanced incentive. For example, a farmer with $500,000 in gross sales and $400,000 in expenses has a net farm income of $100,000. If they sold to a private company, their QBI deduction would be 20% of their $100,000 net income, or $20,000. However, if that farmer sold to a cooperative, the original law allowed a deduction of 20% of their $500,000 gross sales, a $100,000 deduction. This disparity, the “grain glitch,” heavily favored sales to cooperatives and distorted the market.

The Legislative Solution

In response to the market distortions created by the grain glitch, Congress acted quickly. The Consolidated Appropriations Act, 2018, contained the legislative remedy. The law retroactively repealed the language from the TCJA that allowed farmers to calculate their deduction on gross sales to cooperatives. It was replaced with a new framework under a new subsection, Section 199A(g).

This new approach created a balanced system for farmers and the cooperatives they patronize. The solution involves a two-part structure. First, the farmer who sells to a cooperative can claim the standard 20% QBI deduction on their net income from these sales, just like a farmer selling to a private company. This leveled the playing field between the two types of buyers.

The second part of the solution introduces a reduction to the farmer’s deduction. This reduction is tied to a separate deduction that the cooperative itself is now entitled to calculate based on its production activities. The law allows the cooperative to pass this deduction through to its farmer patrons. The farmer’s QBI deduction is then reduced by a portion of this pass-through amount to prevent a double benefit.

Calculating the Deduction for Farmers and Patrons

For a farmer, or patron, calculating the QBI deduction for income from a cooperative is a multi-step process. To complete the calculation, the patron must use the information provided by the cooperative on Form 1099-PATR.

The first step is to calculate the initial QBI deduction. This is 20% of the qualified business income the patron earns from the cooperative, which is the net income from the sales, not the gross payments. For instance, if a farmer has $200,000 in qualified payments from a cooperative and $150,000 in associated expenses, their QBI is $50,000, and the initial deduction is 20% of that, or $10,000.

Next, the patron must calculate a required reduction to this initial amount. The reduction is the lesser of two figures: 9% of the QBI attributable to the cooperative sales, or 50% of the patron’s W-2 wages paid that are allocable to those sales. Using the previous example, if the farmer’s QBI is $50,000, the first part of this test is 9% of $50,000, which is $4,500. If the farmer paid $8,000 in wages related to producing that grain, the second part is 50% of $8,000, or $4,000. The lesser of these two figures is $4,000, so this becomes the required reduction.

The final step is to subtract the reduction from the initial deduction. In this example, the farmer’s final QBI deduction for this cooperative income is $10,000 minus the $4,000 reduction, resulting in a $6,000 deduction. This figure is then combined with any other QBI deductions the farmer may have from other business activities.

Cooperative Calculation and Reporting Duties

The legislative fix under Section 199A(g) established a new deduction for the specified agricultural or horticultural cooperative itself. This deduction is calculated as 9% of the cooperative’s qualified production activities income (QPAI) derived from the products marketed for its patrons. Alternatively, the deduction is limited to 50% of the W-2 wages paid by the cooperative that are attributable to these activities. The cooperative takes the lesser of these two amounts as its own deduction.

A feature of this rule is the cooperative’s ability to “pass through” some or all of this deduction to its patrons. The cooperative can decide what portion of its calculated deduction to retain at the entity level to reduce its own taxable income and what portion to distribute to its members.

This pass-through mechanism creates a reporting duty for the cooperative. The cooperative must provide each patron with the amount of the Section 199A(g) deduction being passed through to them. This information is reported in Box 6 of Form 1099-PATR, “Taxable Distributions Received From Cooperatives.”

Filing and Reporting on Tax Returns

After calculating their final QBI deduction, a farmer must report the figures on their annual income tax return using the appropriate IRS forms. The final calculated QBI deduction amount is entered on Form 1040. This deduction reduces the taxpayer’s adjusted gross income to arrive at their taxable income.

To support the figure claimed on Form 1040, the taxpayer must complete and attach Form 8995-A, “Qualified Business Income Deduction.” While a simpler Form 8995 exists for some taxpayers, the specific calculations involved with cooperative sales require farmers receiving a Form 1099-PATR with a Section 199A(g) deduction to use the more detailed Form 8995-A.

On Form 8995-A, the farmer reports their qualified business income from the cooperative on Schedule D, “Special Rules for Patrons of Agricultural or Horticultural Cooperatives.” This schedule guides the taxpayer through the specific reduction calculation. The final, reduced QBI deduction amount from this form then flows to the main part of Form 8995-A and ultimately to Form 1040.