In-depth Look at 199A & the Case for Non-Qualified Patronage After Tax Reform

Transcription

1 In-depth Look at 199A & the Case for Non-Qualified Patronage After Tax Reform Presented by: Eric Krienert, Tax Director Moss Adams

2 What We Will Cover Today The purpose of this presentation is to: Review how the new 199A law applies Review the technical correction and its impacts on cooperatives and their members. Review non-qualified patronage and its benefits under tax reform Determine next steps, if any Moss Adams LLP 2

3 Background H.R. 1 Tax Cuts and Jobs Act Nov 2 Legislative text first released Nov 9 Approved by House Ways & Means Committee Nov 16 Bill passes House on vote Senate Tax Cuts and Jobs Act Nov 9 Conceptual mark released Nov 16 Approved by Senate Finance Committee Nov 21 Legislative text released Dec 1 Bill passes Senate on vote under budget reconciliation procedures Conference Agreement Tax Cuts and Jobs Act Dec 15 Final House-Senate legislation released Dec 22 President Signs bill into law March 23 Technical Correction 3

4 What does this mean? The Tax Cuts and Jobs Act significantly changed the previous tax structure in a short time period (November 2 nd December 22 nd ) with minimal outside professional review and commentary.

5 Highlights Lowers tax rate for most taxpayers (some single taxpayers will pay more) Limits or eliminates some deductions and credits, but expands others Many changes will cease to apply after 2025 and revert back to pre-2018 law Repeals individual mandate under ACA and responsibility payment starting in 2019 Reduces Corporate tax rate from 35% to 21% Eliminates Corporate AMT Provides for immediate expensing of fixed assets 5

6 Highlights of Tax Cuts and Jobs Act The Tax Cuts and Jobs Act repeals Section 199 (Domestic Production Activities Deduction DPAD ) and puts in its place new Section 199A.

7 IRC Sec Domestic Prodution Activities Deduction Marketing Cooperative Processor/Handler QPAI/Taxable income DPGR $ 50,000,000 COGS 45,000,000 Gross Profit $ 5,000,000 Operating Expenses $ 3,000,000 Income B4 Patronage $ 2,000,000 Patronage $ (2,000,000) Taxable Income $ - Add Back PURPIM $ 45,000,000 Add Back Patronage $ 2,000,000 QPAI $ 47,000,000 (Grower Sales) 9% A $ 4,230,000 W-2 Wages $ 1,880,000 4% of Grower Sales 50% B $ 940,000 Lower of A or B $ 940,000

8 Sunkist Approach on ABC COOP DPAD Approach for 12/31/17 on DPAD (Sec 199) for 12/31/17 Tax Bill eliminated DPAD for all years beginning after 12/31/17, therefore notices must have been sent to patrons by 12/31/17 for individuals to qualify for DPAD deductions DPAD calculated based on coop wages in calendar year ending in fiscal year (7/31) ABC Coop normally distributes DPAD notices in March of each year for the prior fiscal year ABC Coop accelerated 7/31/18 DPAD notification process to allow growers maximum benefit prior to DPAD repeal 2 DPAD notices sent out prior to 12/31 For 7/31/17 (based on calendar year 2016 wages and 7/31/17 fiscal year deliveries) For 7/31/18 (based on calendar year 2017 wages and 7/31/17 fiscal year deliveries) ABC Coop DPAD approach will allow patrons 3 years of deductions in 2017: $12.3M/$0.xxxcarton- FY 7/31/16 DPAD amount based on 12/31/15 wages (notice issued in June 2017) $12.1M/$0.yyycarton- FY 7/31/17 DPAD amount based on 12/31/16 wages $13.9M/$0.zzzcarton- FY 7/31/18 DPAD amount based on 12/31/17 wages

9 I. 199A Basics 9

10 Passthrough Income 199A Allows 20% deduction of qualified business income (QBI) Sunsets in QBI is qualified income, gain, deduction and loss from a partnership, S corporation, or sole proprietorship. Does not include reasonable compensation paid to a shareholder or partner. Does not include specified service trade or business income Law, health, consulting, financial services, or any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees (excluding engineering and architecture). Exception: Specified service trade or business exemption if taxable income does not exceed the threshold amount of $315K (MFJ)/$157.5K (other), phased out over the next $100K.

11 20% Deduction on Qualified Business Income - Section 199A Must be a trade or business Certain services are excluded* Performing services as employee excluded Qualified Business Qualified Business Income Income that is effectively connected to a trade or business in US Certain investment items excluded (including capital gains) Compensation excluded Special loss recapture rule Limitation applies if 20% of qualified trade or business income exceeds:** (A) 50% of W-2 wages; or (B) 25% of W-2 wages and 2.5% of qualified property W-2 and Property Limitations Taxable Income Limitations Deduction cannot exceed 20% of taxable income (less net capital gain) 11 **Service business may be treated as qualified business if taxpayer s income is under certain threshold amounts ** Limitation does not apply if taxpayer s income is under certain threshold amounts. Importantly, the limitations apply on a business-by-business basis. Qualified REIT dividends, and qualified publicly traded partnership income also qualify for the section 199A deduction

12 Pass-through Income Limitation Limitation is phased-in from $315K-$415K (MFJ) 12 For those with taxable income in excess of $415,000 (MFJ) the deduction is limited to the greater of: 50% of W-2 wages or, Sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property

13 Pass-through Income Limitation 13 Unadjusted basis of all qualified property Original Cost Basis (no depreciation) Tangible property subject to Depreciation under IRC Sec. 167 Held by and used in a Qualified Trade or Business, Used at any point during the year in the Production of QBI, and Depreciable period has not ended before the close of the taxable year. Depreciable Period = period beginning on the date the property was 1 st placed in service and ending on the later of The date that is 10 yrs after such date or The last full year in the applicable recovery period that would apply to property under IRC Sec. 168 (without regard to sec (g) (ADS life)). What???

14 Pass-through Income Limitation Unadjusted basis of all qualified property Example: Calendar year taxpayer, Asset placed in service on Jan The cost of that asset can be included in included in the unadjusted basis from 2018 till (any objections?) 14 What about your capitalization policy? What about lazy disposals?

15 AICPA Construction and Real Estate Conference Evaluating the 20% Deduction If a sole proprietor, not involved in a specified service business, had $1,000,000 of QBI with $300,000 of W-2 wages, the sole proprietor and $10,000 of depreciable property you would examine: Lesser of (A) or (B): (A) 20% OF QBI = $200, (B) GREATER OF: 50% of W-2 wages: $150,000; or 25% of W-2 wages: $75,000 plus $2,500 (2.5% of $10,000 )

16 AICPA Construction and Real Estate Conference Maximizing the 20% Deduction Using W-2 To plan to maximize the deduction, TAKE THE QUALIFIED BUSINESS INCOME WITHOUT DEDUCTION FOR WAGES. DIVIDE THIS AMOUNT BY THE ANSWER WOULD BE THE POINT WERE THE WAGES WILL PROVIDE THE MAXIMUM RETURN FOR THE DEDUCTION (KILGORE QUOTIENT)

17 AICPA Construction and Real Estate Conference Example Assume SP has $1,500,000 in net income before deduction of wages To determine W-2 to be $428,571 ($1.5 million/3.5) The net income after wages: $1,071,429 20% of income: $214, % of wages: $214,285.50

18 AICPA Construction and Real Estate Conference 50% of wages Comparison of Limits on QBI Deduction 25% of wages Plus 2.5% of qualified property If 2.5% of QP < 25% of wages, use 50% of wages If 2.5% of QP > 25% of wages, use the sum of the wage/property limit 18

19 The Phase-Out Period If Taxable income allocable to an owner is under $315,000 (MFJ) with no other income, the owner is entitled to 20% reduction because the limits relating to wages or the sum of property or wages do not apply to QBI under $315,000 (MFJ). The limits begin to apply above $315,000 and only if the phaseout of the threshold results in a lesser deduction.

20 Example - Limitation Phase-In #1 A taxpayer filing married jointly with qualified business income from a restaurant of $355,000 (and no other income) with $50K of allocable wages. The calculation is as follows: Taxable Income Threshold Excess $355,000 $315,000 (MFJ) $40,000 $355,000 * 20% = $71,000 QBI Deduction before Wage limitation $71,000 - $25,000 (50% of wages) = $46,000 x 40% phase-in % = $18,400 QBI Deduction Adjustment Allowable QBI Deduction = $52,600 ($71,000 - $18,400)

21 Example - Limitation Phase-In #2 A taxpayer filing married jointly with qualified business income from a law practice of $355,000 (and no other income) with $50K of allocable wages. The calculation is as follows: Taxable Income Threshold Excess $355,000 $315,000 (MFJ) $40,000 ($40,000/$100,000) * 20% = 8% phase in of limitation to specified services. Deduction will be 12% of QBI. $355,000 * 12% = $42,600 QBI Deduction before Wage limitation $42,600 - $25,000 (50% of wages) = $17,600 x 40% phase-in % = $7,040 QBI Deduction Adjustment Allowable QBI Deduction = $35,560 ($42,600 - $7,040)

22 EXAMPLE: S Corporation Owner Lowers Own Wages Pat owns all of S Corp that earns $220,000 of profit before Pat s wages. Pat receives a salary of $100,000 and is in the 24% marginal bracket. Pat is sole employee. If Pat reduces her salary to $60,000, the 199A deduction increases: The 199A deduction: $30,000 ($220,000-$60,000)*0.2 = $32,000 Wage Limit: $60,000*0.5 = $30,000 Compare: The 199A deduction: $24,000 ($220,000-$100,000)*0.2 = $24,000 Wage Limit: $100,000*0.5= $50,000 No payroll taxes were accounted for in this example

23 S Corporation owner raises wages Pat owns all of S Corp operating a retail shop selling expensive widgets and that earns profit of $1,220,000 before wages. Pat receives a salary of $128,000 and her employees are paid a total of $100,000 and is in the 37% marginal bracket. If Pat increases her salary by $120,000 to $248,000, the 199A deduction increases: The 199A deduction: $174,000 ($1,220,000-$348,000)*0.2 = $174,400 Wage Limit: $348,000*0.5 = $174,000 Compare: The 199A deduction: $114,000 ($1,220,000-$228,000)*0.2 = $198,400 Wage Limit: $228,000*0.5 = $114,000 No payroll taxes were accounted for in this example, The savings is in the reduced income after the 199A deduction increased by $60,000.

24 Owner of Commercial Rental Real Estate Pat owns invested in commercial real estate buildings on leased land costing $10,000, years ago. Pat pays $400,000 in wages to maintenance and janitorial employees. Pat earns $2,400,000 in profits before wages. 199A deduction: $350,000.2*($2,400,000-$400,000) = $400,000 Wage limit: 0.5*$400,000 = $200,000 Property/Wage limit Property: 0.025*$10,000,000 = $250,000 Wage Limit: 0.25*$400,000 = $100,000 Property/Wage total $350,000 Lesser of (i) QBI or (ii) the greater of (a) wage limit or (b) property/wage limit. No payroll taxes were taken into account in this example.

25 Owner of Commercial Real Estate with More Wages Pat owns invested in commercial real estate buildings on leased land costing $10,000, years ago. Pat pays $500,000 in wages ($100,000 to Pat s spouse and $400,000 to maintenance and janitorial employees). Pat earns $2,400,000 in profits before wages. 199A deduction: $375,000.2*($2,400,000-$500,000) = $380,000 Wage limit: 0.5*$500,000 = $250,000 Property/Wage limit Property: 0.025*$10,000,000 = $250,000 Wage Limit: 0.25*$500,000 = $125,000 Property/Wage total $375,000 Lesser of (i) QBI or (ii) the greater of (a) wage limit or (b) property/wage limit. No payroll taxes were taken into account in this example.

26 Pass-Through Changes QBI Deduction Example #2 Bill & Joan have $450,000 of pass-through income from three qualified trades or businesses. They also have $200,000 of guaranteed payment income and $100,000 of charitable contribution deductions for net taxable income before the 199A deduction of $550,000. Their QBI Deduction Calculation is as follows: Activity QBI Wages Property 20% QBI 50% Wages Alternate Limitatio n Bill & Joan s QBI deduction would be $77,500. They are not able to pool wages and property to arrive at an overall QBI deduction limitation. QBI calculation is done on an activity-by-activity basis. QBI Deductio n A 500,000 50,000 3,000, ,000 25,000 87,500 87,500 B 250, , ,000 50, ,000 92,500 50,000 C (300,000) 3,000,000 50,000,000 (60,000) 1,500,000 2,000,000 (60,000) Total 450,000 3,350,000 53,300,000 90,000 1,675,000 2,180,000 77,500

27 Pass-Through Changes QBI Deduction Example #3 Assume same facts as the prior example, except Activity C now has a loss of $1M. Their QBI Deduction Calculation is as follows: Activity QBI Wages Property 20% QBI 50% Wages Alternate Limitatio n QBI Deductio n A 500,000 50,000 3,000, ,000 25,000 87,500 87,500 B 250, , ,000 50, ,000 92,500 50,000 C (1,000,000) 3,000,000 50,000,000 (200,000) 1,500,000 2,000,000 (200,000) Total (250,000) 3,350,000 53,300,000 (50,000) 1,675,000 2,180, Bill & Joan s QBI deduction would be zero. Although the QBI calculation is done on an activity-by-activity basis, qualified business income/loss is netted to determine if there is an overall QBI loss. If so, the net loss is carried over and applied to subsequent year.

28 II. Grain Glitch 28

29 Farmer Cooperative Provisions of Tax Cuts and Jobs Act The Tax Cuts and Jobs Act repeals Section 199 (Domestic Production Activities Deduction DPAD ) and puts in its place new Section 199A, which provides: Farmer - A 20% deduction on all qualified payments from a cooperative to its patrons. The deduction cannot exceed the taxpayer s taxable income for the year. Not subject to an additional wage limitation. Note: Only pass-through entities qualify for the 20% deduction, C-Corporations do not as they already are taxed at a lower rate. Cooperative - A 20% deduction for the cooperative on gross income (sales less COGS) less payments to patrons. The deduction is limited to the greater of 50% of wages, or 25% of wages plus 2.5% of the cooperative s investment in property.

30 Tax Reform Benefits for the Cooperative Net Income $ 13,250,000 patronage div deduction CASH $ (1,987,500) * patronage div deduction Qualified Equity $ (5,250,000) ** Illustration of QBI Calculation QBI - 20% (deduction does not reduce cash) $ (6,012,500) +++ $ 180,000,000 Gross Receipts Taxable Ordinary Income $ - $ (140,000,000) COGS $ 40,000,000 Gross Profit Federal Tax Ordinary 34% (2017) 21%(2018) $ - Net Income After Tax $ - $ 13,250,000 Net Income % Member delivery % Cash Flow from Operations $ 13,250,000 $ 9,937,500 Less dividends to shareholders and income taxes $ (1,987,500) After-Tax Cash $ 11,262,500 $ (6,012,500) QBI (20% of the difference between GP and total patronage Notes *and** Cooperative income not subject to tax till the year allocated to patron. ** Qualified Equity allocations add to basis and can be redeemed at any time tax free % Member deliveries 20.00% Cash portion of Patronage refund $ 8,000,000 Max COOP QBI (50% of W-2 Wages) Non-qualified equity allocations reduced qualified equity allocations to maximize QBI and prevent a NOL. ++ IC-DISC structure with a C-Corporation is extremely complex and would need to be carefully evaluated and structured to ensure cash flow to the company remained neautral. +++ QBI deduction limited to 50% of wages, or 25% of wages plus 2.5% of cooperative's investment in property, and cannot create NOL.

31 Tax Reform Benefits for the Farmer selling to a Coop Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) Sales 2,000,000 2,000,000 COGS (1,100,000) (1,100,000) GP 900, ,000 SG&A (700,000) (700,000) farming income b4 QBI deduction 200, ,000 QBI Deduction at 20% (40,000) (370,000) * other Ordinary income 200, ,000 qualifed Dividends/Cap Gain 50,000 50,000 itemized deductions (30,000) (30,000) Taxable Income 380,000 50,000 captial gains rate Wage limitation Yes No Taxable Income limitation Yes Yes Can offset other sources of ordinary income N/A Yes example assumes W-2 wages of at least $80,000 otherwise QBID would be lower * - 20% of Sales to a coop - limited to taxable ordinary income (cannot reduce capital gains or qualifed dividends)

32 199A Cooperative Provisions Too Good to last Private grain handlers and other processor figured out the benefit available to farmers selling to coops and quickly realized that that this would have a major impact on their business Lobbing efforts started right after the 1 st of the year Senators Hoven and Thune are now on record saying that a reasonable solution fix needs to be found. technical correction was demanded When

33 SECTION 199A PROPOSALS 1 Proposal Description Reaction 20% net business income Taxpayer would be allowed a deduction equal to 20% of the lesser of (i) qualified Private grain opposed deduction plus section 199(g) business income; or (ii) taxable income (computed without regard to the deduction). deduction In addition, taxpayer would receive 100% section 199(g) deduction. 2 20% net business income deduction less section 199(g) deduction Taxpayer would be allowed a deduction equal to 20% of the lesser of (i) qualified business income; or (ii) taxable income (computed without regard to the deduction). Taxpayer would reduce the computed 20% deduction by the amount of the section 199(g) deduction. Total deduction would be the reduced 20% deduction plus the (g) pass through. Private grain opposed 3 20% net business income deduction, with option to reduce by 9% income/50% wages and then claim the coop pass through. Ensures the farmer would receive at least a 20% 199A deduction. At the taxpayer s option, the 20% 199A deduction could be reduced by the lesser of 9% of income/50% of wages and the additional pass through deduction could be claimed. Not yet agreed upon 4 20% net business income deduction plus 50% (or negotiated amount) of section 199(g) deduction Taxpayer would be allowed a deduction equal to 20% of the lesser of (i) qualified business income; or (ii) taxable income (computed without regard to the deduction). In addition, taxpayer would add 50% (or another negotiated percentage) of the section 199(g) pass through deduction. Not yet agreed upon 5 20% net business income deduction Taxpayer would be allowed a deduction equal to 20% of the lesser of (i) qualified business income; or (ii) taxable income (computed without regard to the deduction. No section 199(g) permitted. Not yet agreed upon 6 20% net business income deduction reduced by 9% of income/50% of wages if taxpayer does business with a coop. Would also deduct pass through, if any. Taxpayer would be allowed a deduction equal to 20% of the lesser of (i) qualified business income; or (ii) taxable income (computed without regard to the deduction) reduced by lesser of 9% of income/50% of the wages. Reduction of 20% deduction required if taxpayer does business with a cooperative. Taxpayer would be able to deduct coop pass through of 199A(g) deduction, if any. Co-op opposed 7 11% net business income deduction plus section 199(g) deduction. Taxpayer would be allowed a deduction equal to 11% of the lesser of (i) qualified business income; or (ii) taxable income (computed without regard to the deduction). The remaining 9% deduction would be forgone if the taxpayer receives a section 199(g) deduction. Co-op opposed

34 199A Cooperative Technical Correction The omnibus government funding bill filed this evening in the House of Representatives includes amendments to Section 199A intended to address the marketplace impacts of the new deduction. NCFC issued a statement earlier today (see below) commending lawmakers for including the provisions. (The full text of the bill is available here. See page 2033 for the relevant provisions.) The amendments reflect the agreement reached last week between NCFC and independent grain companies and, if enacted, will do the following: Restore prior-law Section 199 treatment and allow patrons to claim a deduction passed through from a cooperative. Change the farmer-level deduction to 20% of taxable income or qualified business income (in line with all other non-corporate taxpayers), with limitations for farmers with high taxable incomes or capital gains. Farmers who transact with a cooperative will also be subject to the following: o The 20% deduction will be reduced by the lesser of (1) 9% of qualified business income allocable to such sales, or (2) 50% of wages allocable to such sales. o This reduction applies regardless of the amount of Section 199A deduction passed through by the cooperative and is intended to replicate the deduction the farmer had foregone by dealing with the cooperative under prior-law section 199. o The co-op member s total deduction for the year will be the pass-through deduction plus the modified 20% deduction. C corporations are not eligible for the 199A deduction. Should the bill be enacted in its current form, NCFC will be circulating a checklist for producers considering ownership restructuring in light of this restriction. The changes to Section 199A are retroactive to January 1, The House and Senate are expected to consider the legislation by the end of this week.

35 NEW LAW QBI OLD LAW DPAD Farmer A Farmer B Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) (Sells via Non-Coop) (Sells via Coop) Sales 1,000,000 1,000,000 1,000,000 1,000,000 Growing & Operating Costs (800,000) (800,000) (800,000) (800,000) T.I. before QBI deduction 200, , , ,000 QBI Deduction at 11% (22,000) New QBI from Coops at 9% or 50% of coop's wages - (20,000) * - Subtotal 200, , , ,000 QBI Deduction at 20% (40,000) - (18,000) DPAD (20,000) * Taxable Income 160, , , ,000 Tax Rate 37% 37% 39.6% 39.6% Tax 59, % 58, % 72, % 71, % 0.37% 0.40% * Assumes coop wages are 4% of payments to patrons (2,000) (2,000) Reduction limited to 9% of Qualified business Income or 50% of wages associated with sales to Cooperatives

36 NEW LAW QBI OLD LAW DPAD Farmer A Farmer B Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) (Sells via Non-Coop) (Sells via Coop) Sales 1,000,000 1,000,000 1,000,000 1,000,000 Growing & Operating Costs (800,000) (800,000) (800,000) (800,000) T.I. before QBI deduction 200, , , ,000 QBI Deduction at 11% (22,000) New QBI from Coops at 9% or 50% of coop's wages - - * - Subtotal 200, , , ,000 QBI Deduction at 20% (40,000) - (18,000) DPAD - * Taxable Income 160, , , ,000 Tax Rate 37% 37% 39.6% 39.6% Tax 59, % 65, % 72, % 79, % -3.33% -3.56% * Assumes coop has no w-2 Wages 18,000 18,000 Reduction limited to 9% of Qualified business Income or 50% of wages associated with sales to Cooperatives

37 NEW LAW QBI OLD LAW DPAD Farmer A Farmer B Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) (Sells via Non-Coop) (Sells via Coop) Sales 1,000,000 1,000,000 1,000,000 1,000,000 Growing & Operating Costs (800,000) (800,000) (800,000) (800,000) T.I. before QBI deduction 200, , , ,000 QBI Deduction at 11% (22,000) New QBI from Coops at 9% or 50% of coop's wages - (90,000) * - Subtotal 200,000 88, , ,000 QBI Deduction at 20% (40,000) - (18,000) DPAD (90,000) * Taxable Income 160,000 88, , ,000 Tax Rate 37% 37% 39.6% 39.6% Tax 59, % 32, % 72, % 43, % 13.32% 14.26% * Assumes coop wages are 18% (or higher) of payments to patrons (72,000) (72,000) Reduction limited to 9% of Qualified business Income or 50% of wages associated with sales to Cooperatives

38 Illustration Only for Discussion Purposes Only 5.5% Coop's Wages as a % of payments to Growers (a) Without W-2 Wages With W-2 Wages Farmer A Farmer B Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) (Sells via Non-Coop) (Sells via Coop) Sales 900,000 (a) 900, ,000 (a) 900,000 Growing & Operating Costs W-2 wages - - (80,000) (80,000) other (800,000) (800,000) (720,000) (720,000) (800,000) (800,000) (800,000) (800,000) T.I. before QBI deduction 100, , , ,000 QBI Deduction at 20% (20,000) (20,000) (20,000) (20,000) QBI reduction for Co-Op Patro ,000 New QBI from Coops at 9% or 50% of coop's wages - (24,750) - (24,750) New QBI deduction (20,000) (44,750) (20,000) (35,750) Taxable Income 80,000 55,250 80,000 64,250 Tax Rate 37% 37% 37% 37% Tax 29, % 20, % 29, % 23, % 9.16% 5.83% Wage limitation: QBI from Coops n/a At Coop Level Only QBI reduction for the co-op patron: QBI Yes-if TI above $315,000 Yes-if TI above $315,000 Take the 199A(a) calculation above and reduce the deduction by the lesser of : - 9% of farm income from the co-op or Taxable Income limitation: - 50% of wages applicable to sales to the co-op QBI from Coops n/a Yes QBI Yes Yes Prepared by: Eric Krienert, CPA Moss Adams of income: QBI from Coops n/a yes eric.krienert@mossadams.com QBI No No Can offset other sources

39 Illustration Only for Discussion Purposes Only 4.0% Coop's Wages as a % of payments to Growers (a) Without W-2 Wages With W-2 Wages Farmer A Farmer B Farmer A Farmer B (Sells via Non-Coop) (Sells via Coop) (Sells via Non-Coop) (Sells via Coop) Sales 1,300,000 (a) 1,300,000 1,300,000 (a) 1,300,000 Growing & Operating Costs W-2 wages - - (80,000) (80,000) other (800,000) (800,000) (720,000) (720,000) (800,000) (800,000) (800,000) (800,000) T.I. before QBI deduction 500, , , ,000 QBI Deduction at 20% - - (40,000) (40,000) QBI reduction for Co-Op Pat ,000 New QBI from Coops at 9% or 50% of coop's wages - (26,000) - (26,000) New QBI deduction - (26,000) (40,000) (26,000) Taxable Income 500, , , ,000 Tax Rate 37% 37% 37% 37% Tax 185, % 175, % 170, % 175, % 1.92% -1.04% Wage limitation: QBI from Coops n/a At Coop Level Only QBI reduction for the co-op patron: QBI Yes-if TI above $315,000 Yes-if TI above $315,000 Take the 199A(a) calculation above and reduce the deduction by the lesser of : - 9% of farm income from the co-op or Taxable Income limitation: - 50% of wages applicable to sales to the co-op QBI from Coops n/a Yes QBI Yes Yes Prepared by: Eric Krienert, CPA Moss Adams of income: QBI from Coops n/a yes eric.krienert@mossadams.com QBI No No Can offset other sources

40 II. Non-Qualified Patronage Top corporate rate reduced from 35% to 21%. 40

41 Corporate rate reduction For fiscal years beginning after 12/31/2017, the corporate tax rate is reduced to 21%. A blended rate will apply to fiscal year corporate taxpayers for the year straddling 12/31/2017. As discussed later, the corporate alternative minimum tax (AMT) has been repealed. 41

42 Other rates Individual rates on wages and other ordinary income reduced somewhat, but there are still multiple brackets 10%, 12%, 22%, 24%, 32%, 35% and 37%. Business income from sole proprietorships and passthrough entities is subject to somewhat reduced rates new Section 199A. Long-term capital gains and dividends are still taxed at old reduced rates. 42

43 Most individuals received a tax rate reduction Most individuals received a tax rate reduction Individuals: Married filing jointly Other changes to tax rules have varied impact on individuals (i.e., state and local taxes capped at $10k; standard exemption doubling) 43

44 This represents a notable change The corporate rate is now significantly lower than the maximum rate applicable to individuals, something that has not been the case since the 1970s. The tipping point for ordinary income, for a married couple filing jointly, the individual marginal rate exceeds the corporate tax rate for income in excess of $165,000 (22%+ vs. 21%). 44

45 This represents a notable change 20% 11% MFJ - Taxable Income Tax Rate QBI Ded Net Rate QBI Ded Net Rate - 19, % -2.0% 8.0% -1.1% 8.9% 19,051 77, % -2.4% 9.6% -1.3% 10.7% 77, , % -4.4% 17.6% -2.4% 19.6% 165, , % -4.8% 19.2% -2.6% 21.4% 315, , % -6.4% 25.6% -3.5% 28.5% 400, , % -7.0% 28.0% -3.9% 31.2% 600, % -7.4% 29.6% -4.1% 32.9% 45

46 Implications This change and others are causing taxpayers to rethink tax strategies. What are the implications for how patronage dividends should be paid? 21% tax rate vs. 20% cash requirement. Tax rates are only one piece of the puzzle. Note: the corporate rate change is permanent; the individual changes sunset after 2025 unless Congress acts to make them permanent or to extend them. I think the case for Non-Qualifed Certificates just got stronger 46

47 Treatment of net operating losses Net operating losses (NOLs) incurred in taxable years beginning after 12/31/17 can no longer be carried back, but they can be carried over indefinitely. Most special categories of loss carryovers have been eliminated (e.g., specified liability losses). NOLs may offset only 80% of taxable income. Before or after Patronage? 47

48 Treatment of net operating losses Book basis Coop has a book loss How do you allocated M-1s between Pat and Non-Pat? If you allocate all to non-pat then we have a problem See DFA loss PLR for ordering rules Generally patronage before NOL Tax basis coops have same issue Coops will pay tax on Patronage income! Can we use Non-Quals to solve the problem Marketing coops could use Non-Qual Per-Unit Retain Certificates. What about supply Coops Should we cancel old Equities? 48

49 The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. Assurance, tax, and consulting offered through Moss Adams LLP. Wealth management offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC. 49