Section 199A Rules for Cooperatives and Their Patrons

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9947]

RIN 1545-B090

Section 199A Rules for Cooperatives and Their Patrons

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations and removal of final and temporary regulations.

SUMMARY:

This document contains final regulations that provide guidance to cooperatives to which sections 1381 through 1388 of the Internal Revenue Code (Code) apply (Cooperatives) and their patrons regarding the deduction provided by section 199A(a) of the Code for qualified business income (QBI), as well as guidance to specified agricultural or horticultural cooperatives (Specified Cooperatives) and their patrons regarding the deduction provided by section 199A(g) of the Code for eligible domestic production activities undertaken by Specified Cooperatives. The final regulations also provide guidance on section 199A(b)(7), the statutory rule requiring patrons of Specified Cooperatives to reduce their QBI deduction under section 199A(a). In addition, the final regulations include a definition of

patronage and nonpatronage sourced items

under section 1388 of the Code, and revise existing regulations under section 1382 of the Code to reference this definition. Finally, this document removes the final and temporary regulations under former section 199. These final regulations affect Cooperatives as well as patrons that are individuals, partnerships, S corporations, trusts, and estates engaged in domestic trades or businesses.

DATES:

Effective date:

These regulations are effective on January 14, 2021.

Applicability dates:

For dates of applicability, see §§ 1.199A-7(h), 1.199A-8(h), 1.199A-9(k), 1.199A-10(i), 1.199A-11(h), 1.199A-12(j), 1.1382-3(e), and 1.1388-1(g).

FOR FURTHER INFORMATION CONTACT:

Jason Deirmenjian at (202) 317-4470 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26 CFR part 1) under sections 199A, 1382, and 1388 of the Code.

Section 199A was enacted on December 22, 2017, by section 11011 of Public Law 115-97, 131 Stat. 2054, 2063, commonly referred to as the Tax Cuts and Jobs Act (TCJA). Parts of section 199A were amended on March 23, 2018, effective as if included in the TCJA, by section 101 of Division T of the Consolidated Appropriations Act, 2018, Public Law 115-141, 132 Stat. 348, 1151 (2018 Act). Section 199A applies to taxable years beginning after 2017 and before 2026. Unless otherwise indicated, all references to section 199A are to section 199A as amended by the 2018 Act.

In addition, section 13305 of the TCJA repealed section 199 (former section 199), which provided a deduction for income attributable to domestic production activities (section 199 deduction). Public Law 115-97, 131 Stat. 2054, 2126. The repeal of former section 199 is effective for all taxable years beginning after 2017.

Section 199A(a) provides taxpayers a deduction of up to 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate, and up to 20 percent of qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income (section 199A(a) deduction). Section 199A(b)(7) requires patrons of Specified Cooperatives to reduce their section 199A(a) deduction if those patrons receive certain payments from Specified Cooperatives.

Section 199A(g) provides a deduction for Specified Cooperatives and their patrons (section 199A(g) deduction) that is based on the former section 199 deduction. Section 199A(g)(4)(A) defines a Specified Cooperative, in part, as an organization to which part I of subchapter T of chapter 1 of the Code (subchapter T) applies. Under section 1381(a)(2), subchapter T applies to any corporation operating on a cooperative basis, with certain exceptions not relevant here. Section 1382 provides rules regarding the taxable income of Cooperatives and section 1388 provides definitions applicable for purposes of subchapter T.

The Department of the Treasury (Treasury Department) and the IRS published proposed regulations (REG-107892-18) providing guidance on the section 199A(a) deduction in the

Federal Register

(83 FR 40884) on August 16, 2018. A second notice of proposed rulemaking providing guidance (REG-134652-18) and final regulations implementing the section 199A(a) deduction (TD 9847) were published in the

Federal Register

(84 FR 3015 and 84 FR 2952, respectively) on February 8, 2019, with corrections to TD 9847 published in the

Federal Register

(84 FR 15954) on April 17, 2019. TD 9847, which promulgated §§ 1.199A-1 through 1.199A-6 to implement the section 199A(a) deduction, does not include all the rules needed for patrons of Cooperatives to calculate their particular section 199A(a) deductions. Specifically, the rules included in TD 9847 do not address patrons' treatment of payments received from Cooperatives for purposes of section 199A(a) or the section 199A(g) deduction for Specified Cooperatives, though § 1.199A-1(e)(7) restates the reduction to a patron's section 199A(a) deduction required under section 199A(b)(7).

To address these matters, on June 19, 2019, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-118425-18) in the

Federal Register

(84 FR 28668) containing proposed regulations under sections 199A and 1388, with corrections published in the

Federal Register

(84 FR 38148) on August 6, 2019 (together, Proposed Regulations). The Proposed Regulations set forth rules to address patrons' treatment of payments received from Cooperatives for purposes of section 199A(a) and the section 199A(g) deduction for Specified Cooperatives in proposed §§ 1.199A-7 through 1.199A-12, as well as proposed rules under section 1388 regarding patronage and nonpatronage sources of income of Cooperatives. The Proposed Regulations also withdrew all proposed regulations issued under former section 199 that had not been finalized and proposed to remove the final and temporary regulations under former section 199.

The Summary of Comments and Explanation of Revisions of the final regulations summarizes the provisions of the Proposed Regulations, which are explained in greater detail in the preamble to the Proposed Regulations. After full consideration of the comments received on the Proposed Regulations, this Treasury decision adopts the Proposed Regulations with modifications in response to such comments as described in the Summary of Comments and Explanation of Revisions.

Summary of Comments and Explanation of Revisions

The purpose and scope of the final regulations is limited to providing guidance regarding the application of sections 199A(a), 199A(b)(7), 199A(g), 1382, and 1388. Section 199A(a) is generally applicable to patrons of all

Cooperatives, whereas sections 199A(b)(7) and 199A(g) apply only to Specified Cooperatives and their patrons. Section 1388 generally applies to all Cooperatives and their patrons.

The Treasury Department and the IRS received written comment submissions in response to the Proposed Regulations. All comments were considered and are available at

www.regulations.gov

or upon request. Most of the comments addressing the Proposed Regulations are summarized in this Summary of Comments and Explanation of Revisions. However, comments merely summarizing or interpreting the Proposed Regulations, recommending statutory revisions, or addressing issues which are outside the scope of the final regulations are not discussed in this Summary of Comments and Explanation of Revisions.

Commenters requested that the rules for section 199A as they apply to Cooperatives and patrons be simplified and clarified. Accordingly, while the final regulations adopt many of the rules described in the Proposed Regulations, they are revised in response to the comments received. Additionally, in response to the comments, the final regulations include clarifying language and additional examples.

Parts I through VII of this Summary of Comments and Explanation of Revisions discuss §§ 1.199A-7 through 1.199A-12, 1.1382-3, and 1.1388-1, respectively. Part VIII addresses the removal of all final and temporary regulations issued under former section 199. Part IX addresses comments on the proposed applicability date and the transition rule.

I. § 1.199A-7, Rules for Patrons of Cooperatives

A. In General

As noted in the Background, the section 199A(a) deduction allows taxpayers to deduct up to 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate, and up to 20 percent of qualified REIT dividends and PTP income. Patrons that are individuals (as described in § 1.199A-1(a)(2)) are eligible for the section 199A(a) deduction. If patrons receive certain payments from Specified Cooperatives, then section 199A(b)(7) requires them to calculate a reduction to their section 199A(a) deduction. This part I.A provides a general outline of the rules of proposed § 1.199A-7, and the remainder of this part I addresses the specific comments received on proposed § 1.199A-7. Other than for modifications made in response to specific comments, the final regulations generally adopt the Proposed Regulations.

Proposed § 1.199A-7(a) provides special rules and definitions for patrons of cooperatives in applying §§ 1.199A-1 through -6, including definitions of patron, patronage and nonpatronage, qualified payment, and Specified Cooperative. Proposed § 1.199A-7(b) explains that patronage dividends or similar payments that a patron receives from a Cooperative are considered as generated from the trade or business the Cooperative conducts on behalf of the patron, and are therefore tested by the Cooperative at its trade or business level. Proposed § 1.199A-7(c) provides special rules for patrons and Cooperatives relating to the definition of QBI, the determination of QBI by patrons, and the determination and reporting by Cooperatives of the amount of qualified items of income, gain, deduction, and loss (collectively, qualified items) for qualified trades or businesses in distributions made to patrons. Proposed § 1.199A-7(d) provides special rules for patrons' determinations of specified service trades or businesses (SSTBs) and for Cooperatives' determination and reporting of SSTBs.

Under proposed § 1.199A-7(c)(3) and (d)(3), Cooperatives are required to report the amount of qualified items related to non-SSTBs and SSTBs in distributions made to patrons on an attachment to or on the Form 1099-PATR (or any successor form), unless the form instructions provide otherwise. Under proposed § 1.199A-7(c)(3), if a Cooperative fails to report the amount of qualified items from its non-SSTBs, then the amount of distributions from the Cooperative that may be included in the patron's QBI is presumed to be zero. Under proposed § 1.199A-7(d)(3), if a Cooperative fails to report the amount of qualified items from an SSTB (SSTB items), then only the amount of qualified items the Cooperative reports under proposed § 1.199A-7(c)(3) may be included in the patron's QBI, and the remaining amount of distributions from the Cooperative is presumed to not be included in the patron's QBI.

Proposed § 1.199A-7(e) provides special rules for patrons relating to the statutory limitations based on W-2 wages and unadjusted basis immediately after acquisition (UBIA) of qualified property. The Proposed Regulations provide that Cooperatives do not allocate their W-2 wages and UBIA of qualified property to patrons, and directs patrons to calculate the W-2 wage and UBIA of qualified property limitations at the patron level when calculating their section 199A(a) deduction.

Proposed § 1.199A-7(f) provides special rules for Specified Cooperatives and their patrons relating to calculating the section 199A(b)(7) reduction, including a requirement that Cooperatives report the amount of qualified payments (as defined in proposed § 1.199A-8(d)(2)(ii)) made to patrons on an attachment to or on the Form 1099-PATR (or any successor form). Proposed § 1.199A-7(g) provides examples that illustrate the rules in § 1.199A-7(a) through (f) for Specified Cooperatives and their patrons.

Lastly, proposed § 1.199A-7(h) generally provides that taxpayers may rely on the proposed rules in their entirety and as applied in a consistent manner until final regulations are published in the

Federal Register

. Proposed § 1.199A-7(h) also includes the transition rule relating to the repeal of the former section 199 deduction and the implementation of the new section 199A(a) deduction.

B. Comments Related to Proposed §§ 1.199A-7(c)(3) and (d)(3)

i. Requirements That Cooperative Determines Qualified Items From Non-SSTBs and Qualified Items From SSTBs

Under proposed §§ 1.199A-7(c)(3) and (d)(3), Cooperatives must separately determine the amounts of qualified items relating to non-SSTBs and qualified items relating to SSTBs in distributions made to patrons. Commenters asserted that whether income is a qualified item when earned at the Cooperative level should not be determinative of its treatment at the patron level, but that instead the determination of qualified items from non-SSTBs and SSTBs should be made by the patron based solely on whether a patronage dividend relates to a patron's trade or business. These commenters additionally asserted that the proposed rules burden Cooperatives by requiring additional information reporting and are not consistent with the provisions of subchapter T.

The final regulations do not adopt the commenters' suggestion for several reasons, including that the proposal does not comport with sections 199A(c)(3) and (d)(2). The rules of proposed §§ 1.199A-7(c)(3) and (d)(3) are consistent with the rules in TD 9847 implementing the section 199A(a) deduction generally. These rules arise from the statutory requirement that all items in the computation of the section 199A(a) deduction be qualified items as defined in section 199A(c)(3) and not

derived from an SSTB as defined in section 199A(d)(2). TD 9847 generally provides that an item of income, gain, deduction and loss is determined and reported for each trade or business by the entity or individual that directly conducts the trade or business. Patronage dividends and similar payments are considered to be directly generated from the trade or business that the Cooperative conducts on behalf of or with its patrons. For example, an individual patron must determine QBI for each trade or business it directly conducts. To the extent a patron receives patronage dividends or similar payments from a Cooperative, such patronage dividends or similar payments are considered generated from the trade or business the Cooperative conducts on behalf of or with its patron and are tested by the Cooperative at the level of its trade or business.

Failure to determine whether items of income, gain, deduction, and loss that are distributed to patrons are qualified items at the Cooperative level could result in patrons' circumvention of the statutory requirements for qualified items under section 199A(c)(3)(A) and (B), for example, that items be effectively connected with the conduct of a trade or business within the United States. Section 199A(c)(3)(B) lists items that are not treated as qualified items defined in section 199A(c)(3). All dividends, income equivalent to dividends, or payments in lieu of dividends described in section 954(c)(1)(G) are not qualified items. However, section 199A(c)(3)(B)(ii) also specifically provides that patronage dividends are not treated as dividends, income equivalent to dividends, or payments in lieu of dividends described in section 954(c)(1)(G), which means a patronage dividend can be taken into account as a qualified item to the extent otherwise qualified. The Joint Committee on Taxation report titled “Technical Explanation of the Revenue Provisions of the House Amendment to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66)” (JCX-6-18, released March 22, 2018) (Joint Committee Report) further clarified that other similar amounts received from Cooperatives can be included in QBI, provided those amounts are otherwise a qualified item. Joint Committee on Taxation, JCX-6-18, Technical Explanation of the Revenue Provisions of the House Amendment to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66) 25 (March 22, 2018). As a result, the Proposed Regulations define a qualified item as including a distribution for which a Cooperative is allowed a deduction under section 1382(b) or (c)(2) (including patronage dividends and other similar payments, such as money, property, qualified written notices of allocation, and qualified per-unit retain certificates, as well as money or property paid in redemption of a nonqualified written notice of allocation), provided the distribution is otherwise a qualified item. Therefore, to be a qualified item under section 199A(c)(3), patronage dividends and other similar payments must still be effectively connected (section 199A(c)(3)(A)(i)), included or allowed in income (section 199A(c)(3)(A)(ii)), and not represent amounts described in section 199A(c)(3)(B)(i) and (iii)-(vii). Additionally, items of income, gain, deduction, and loss from an SSTB are not includable in QBI with respect to individuals above the threshold amount and subject to the phase-in range under section 199A(d)(3). Any potential burden to the Cooperatives in making these determinations is outweighed by the patrons' need for this information to determine their section 199A(a) deduction.

Based upon these statutory requirements and because the Cooperative is better positioned than a patron to determine whether a patronage dividend or other similar payment is a qualified item as determined under the rules of § 199A(c)(3) and § 1.199A-3(b) and whether it is derived from an SSTB as defined in § 199A(d)(2) and § 1.199A-5, these determination rules are adopted in the final regulations without substantive change. The patron then determines if the qualified item is includible in the patron's QBI under § 1.199A-7(c)(2) and whether the qualified item from the SSTB is includible in the patron's QBI based on the threshold rules in § 199A(d)(3) and § 1.199A-5(a)(2)). There is no duplication in effort between the Cooperative and the patron with respect to these determinations. However, in response to commenters, the reporting requirements of Cooperatives have been modified to balance the burden on the Cooperatives and the patrons' need to receive information to determine their section 199A(a) deduction.

ii. Requirements That Cooperative Report Qualified Items From Non-SSTBs, Qualified Items From SSTBs, and Qualified Payments

Proposed §§ 1.199A-7(c)(3), (d)(3), and (f)(3) require Cooperatives to report qualified items from non-SSTBs, qualified items from SSTBs, and qualified payments (qualified payments are relevant only for Specified Cooperatives) to patrons. A commenter opposed these reporting requirements on the grounds that the requirements did not exist under former section 199 and do not exist under section 6044(b). In the commenter's view, Congress would have amended section 6044 to that effect if the reporting requirements were intended. The Treasury Department and the IRS agree that versions of Form 1099-PATR prior to the enactment of section 199A did not include a box for qualified payments and that section 6044(b) does not require reporting of these amounts. However, unlike former section 199, information concerning all of these amounts (qualified payments as applicable) are required for a patron to calculate its section 199A(a) deduction, including the reduction under section 199A(b)(7) for patrons of Specified Cooperatives, which did not exist under former section 199. Therefore, it is necessary for patrons to have this information, and it is most efficient for patrons to receive the information from Cooperatives on Form 1099-PATR (or any successor form). Additionally, section 199A(f)(4) authorizes the Treasury Department and the IRS to prescribe such regulations as are necessary to carry out the purposes of section 199A, including reporting requirements.

The commenter also requested removal of these reporting requirements on the grounds that Cooperatives should not be treated as relevant passthrough entities (RPEs). The Treasury Department and the IRS agree that Cooperatives are not RPEs. However, these reporting requirements emanate from the statutory requirements of section 199A and not the nature of the entities. These reporting requirements are imposed on Cooperatives because sections 199A(c) and (d) require that items of income, gain, deduction, and loss be of a certain character and from a qualified trade or business when determining the section 199A(a) deduction, and patrons need this information to determine their section 199A(a) deduction. Further, the reporting requirements applicable to Cooperatives are distinguishable from those imposed on RPEs because RPEs are required to engage in more detailed reporting, including reporting W-2 wages and UBIA of qualified property.

After consideration of the comments, the final regulations maintain a reporting requirement for Cooperatives, but the rules in proposed § 1.199A-7(c)(3) and (d)(3) are revised to simplify the Cooperative's reporting obligation with respect to qualified items from

non-SSTBs and qualified items from SSTBs. The proposed regulations required that the Cooperative report the amounts of qualified items with respect to each non-SSTB of the Cooperative, with a similar requirement for SSTBs. However, to reduce burden and clarify that Cooperatives do not make trade or business and corresponding aggregation determinations, the final regulations require the Cooperative to report the total net amount of qualified items from non-SSTBs in distributions to patrons without delineating these amounts business by business. A similar change was made to the reporting requirements for qualified items in distributions from SSTBs. Patrons then determine the extent that those payments are included in the QBI of the patrons' trade or business. For example, a patron will determine whether those payments are related to the patron's trade or business and whether any items in the SSTB distributions reported by the Cooperative are includible as qualified items of income, gain, deduction and loss at the patron's level after consideration of the threshold and phase-in amounts as applied to the patron's taxable income. In addition, the rules in proposed § 1.199A-7(b) are revised for consistency with the revision to proposed § 1.199A-7(c)(3) and (d)(3).

Commenter also suggested that the SSTB reporting requirements be revised to reflect that if a Cooperative provides services from SSTBs to patrons, the services are provided to patrons, not third parties. Therefore, any patronage dividends should be deemed a rebate, which would increase QBI of the patrons to its proper amount. Further, if the SSTBs conducted by the Cooperatives relate to personal expenses of a patron, then the SSTB patronage dividends should be excluded from the QBI calculation, but done so at the patron level, because only the patron would know whether the SSTB service is a personal expense.

Based on the commenter's suggestions, the Treasury Department and the IRS considered whether additional rules were needed and concluded that revisions are necessary to resolve certain questions raised by the commenter. Consider an example where a Cooperative provides a service to patrons as part of an SSTB of the Cooperative under section 199A(d)(2). Assume that a patron's use of that service is a deductible expense to its qualified trade or business. Patron pays the Cooperative $1,000 for the service. The Cooperative later pays the patron a patronage dividend of $50 related to the service. This patronage dividend is income under section 1385(a)(1) to the patron. Under the Proposed Regulations, assuming the patron's income is over the threshold amount (defined in section 199A(e)(2)), the patron would not be able to include the $50 in its calculation of QBI because it is SSTB income. Meanwhile, the patron would have a $1,000 expense that would reduce QBI. In substance, however, the patron would have only paid $950 for the service.

The Treasury Department and the IRS considered two approaches for resolving this asymmetry. One approach (suggested by a commenter) would permit a patron paying for services from an SSTB of the Cooperative for its trade or business to treat any patronage dividends related to those amounts as qualified items (or rebates that would reduce the expense), regardless of the threshold amounts, if the services were required or used in a qualified trade or business of the patron. A second approach would permit the allocation of part of the patron's expense to the non-qualified SSTB income. To reach the correct result, this second approach would limit the allocation of the expense to the amount of SSTB income of the Cooperative that relates to the patron's expense. Under the second approach, a patron could allocate expenses between its qualified trade or business income and the SSTB income up to the amount of the patronage dividend. Either approach reaches a similar end result with respect to the example—that is, the patron having a net $950 expense included within QBI. However, the first approach conflicts with section 199A(d)(2) in that SSTB income cannot be treated as QBI, unless the section 199A(d)(3) exception applies. The first approach also conflicts with section 1385(a)(1), which requires inclusion of patronage dividends in income, unless an exception is met under section 1385(b). In contrast, the second approach does not conflict with either the requirements of section 199A or section 1385(a)(1). Also, the commenter noted, the patron's exception to income from patronage dividends for personal, living, or family items is met under section 1385(b)(2). For clarification in that case, the patron will have to make that determination, and none of the expense or patronage dividend should be taken into account for purposes of QBI. Based on this analysis, the final regulations in § 1.199A-7(d)(3)(ii) adopt the second approach, and include an example illustrating the application of this approach.

iii. Relief From Zero-Presumption Rule

As discussed previously, if a Cooperative fails to timely report qualified items and SSTB items, proposed §§ 1.199A-7(c)(3) and (d)(3) provide that the amount of distributions from the Cooperative that may be included in the patron's QBI is presumed to be zero (zero-presumption rule). Commenters requested relief from the zero-presumption rule on the basis that Cooperatives may not be aware of the reporting requirements and may negligently fail to issue Forms 1099-PATR in a timely manner. For tax year 2019 filing, Cooperatives can report qualified payments on the Form 1099-PATR and can attach a supplemental schedule disclosing qualified items and SSTB items to patrons. For future filing years, the Form 1099-PATR will be updated to include boxes for qualified items and SSTB items. The final regulations do not provide relief from the zero-presumption rule, since the zero-presumption rule is a presumption that the patron may rebut with appropriate evidence or documentation. One example of appropriate evidence or documentation would be a corrected Form 1099-PATR received by the patron from the Cooperative.

C. Comments Related to Proposed § 1.199A-7(f), Special Rules for Patrons of Specified Cooperatives

i. Requirement for Patrons To Compute the Section 199A(b)(7) Reduction

The section 199A(b)(7) reduction is a statutory rule requiring, in the case of any qualified trade or business of a patron of a Specified Cooperative, that the amount determined under section 199A(b)(2) with respect to the trade or business be reduced by the lesser of (A) 9 percent of so much of the QBI with respect to the trade of business as is properly allocable to qualified payments (as defined in section 199A(g)(2)(E) and § 1.199A-8(d)(2)(ii)), or (B) 50 percent of so much of the W-2 wages with respect to the trade or business as are so allocable. Proposed § 1.199A-7(f)(1) provides that a patron of a Specified Cooperative that receives a qualified payment must reduce its section 199A(a) deduction as provided in § 1.199A-1(e)(7) (which follows the language of section 199A(b)(7)), and the reduction applies whether the Specified Cooperative passes through all, some, or none of the Specified Cooperative's section 199A(g) deduction to the patron in the taxable year.

Commenters requested an opt-out provision whereby patrons and Specified Cooperatives could elect out of the rules under sections 199A(b)(7)

and (g). The final regulations do not adopt this request. There is no statutory provision providing for an opt-out of these Code sections. In the parallel situation under former section 199, there also was no opt-out provision. Specifically, the no-double-counting rule under former § 1.199-6(l) precluded farmers from including qualified payments in their own former section 199 deduction. Further, permitting patrons and Specified Cooperatives to elect out of the rules under sections 199A(b)(7) and (g) would be difficult to administer and could result in patrons and Specified Cooperatives taking conflicting positions.

Some commenters have reasoned that turning off the section 199A(b)(7) reduction is justified based on the part of the qualified payment definition in section 199A(g)(2)(E)(iii), whereby the payment must be attributable to qualified production activities income (QPAI) with respect to which a deduction is allowed to the Specified Cooperative under section 199A(g)(1). However, section 199A(b)(7) applies when qualified payments are received by a patron in a qualified trade or business. The determination of whether a qualified payment was received is a different issue and is addressed in part II of this Summary of Comments and Explanation of Revisions.

ii. Comments on Interaction of Section 199A(b)(7) Reduction and § 1.199A-4

Commenters requested clarification on how the section 199A(b)(7) reduction operates with the aggregation rules in § 1.199A-4. In certain circumstances, an individual may aggregate two or more trades or businesses for purposes of the QBI component calculation in § 1.199A-1(d)(2)(iv), which includes application of the W-2 wage and UBIA of qualified property limitations under section 199A(b)(2). Aggregation is permitted but not required. Once an individual chooses to aggregate two or more trades or businesses, the individual must consistently report the aggregated trades or businesses in all subsequent taxable years. As commenters point out, aggregation of two or more trades or businesses may be favored by a taxpayer because it may provide better results when applying the W-2 wage and UBIA of qualified property limitations.

Commenters asked for clarification in two situations. First, commenters asked whether a patron who aggregates a rental real estate business and a farming business conducted with or through a Specified Cooperative may exclude the rental income from the section 199A(b)(7) reduction. This question relates to clarifying the rule in proposed § 1.199A-7(f)(2)(i), which provides that for purposes of calculating the section 199A(b)(7) reduction, a patron must use a reasonable method based on all the facts and circumstances to allocate between income that is from qualified payments and income that is not from qualified payments. As a clarification, income that is not related to qualified payments can be earned in transactions that do not involve Specified Cooperatives, for example, a grain sale to a noncooperative customer. This means that the rental income, which is not income related to qualified payments, should be excluded when calculating the section 199A(b)(7) reduction for the aggregated trade or business.

Second, commenters asked whether in that same situation a patron is permitted to allocate the rental expenses toward the income from the Specified Cooperative, thus possibly lowering the section 199A(b)(7) reduction. Proposed § 1.199A-7(f)(2)(i) provides that for purposes of calculating the section 199A(b)(7) reduction, a patron must use a reasonable method to allocate income items and related deductions. Thus, it would be reasonable to allocate that expense against qualified payments when calculating the section 199A(b)(7) reduction only to the extent the rental expense is related to the qualified payments from the Specified Cooperative. These aggregation principles are applied throughout the rules and examples of the final regulations and are consistent with the Proposed Regulations.

Commenters also inquired as to how negative QBI allocable to qualified payments affects the section 199A(b)(7) reduction. The Treasury Department and the IRS considered this comment and determined that there would be no section 199A(b)(7) reduction in such a case. An example illustrating this is a farmer conducting two types of agricultural businesses (A and B). Assume the farmer treats A and B as one trade or business for purposes of the section 199A(a) deduction. The farmer conducts A with non-Specified Cooperatives and B through a Specified Cooperative. The farmer generates $100 of qualifying income through A and receives $100 of qualifying income from a Specified Cooperative in B, all of which is also a qualified payment. The farmer has $180 of qualified expenses. For purposes of the section 199A(a) deduction, the farmer's QBI ($20) from the trade or business is used to calculate the deduction, resulting in a $4 deduction (assuming there is no limitation under section 199A(b)(2)(B)). The farmer then must determine if there is any section 199A(b)(7) reduction to this amount. The farmer reasonably allocates its qualified expenses under § 1.199A-7(f)(2)(i) for purposes of calculating the section 199A(b)(7) reduction, and determines $110 of the qualified expenses are allocable to B (and $70 to A). The farmer will use only QBI from B to calculate the section 199A(b)(7) reduction because that is the only QBI properly allocable to qualified payments. Farmer's QBI for purposes of section 199A(b)(7)(A) is negative $10, resulting in a $0 section 199A(b)(7) reduction (regardless of W-2 wages under section 199A(b)(7)(B)).

iii. Comments on Safe Harbor Allocation Method in Proposed § 1.199A-7(f)(2)(ii)

Proposed § 1.199A-7(f)(2)(ii) is a safe harbor providing a reasonable method for patrons with income under the threshold amount (set forth in section 199A(e)(2)) to allocate deductions and W-2 wages between income or gain related to qualified payments and income or gain that is not related to qualified payments when determining the section 199A(b)(7) reduction with respect to a patron's qualified trade or business. The method allows patrons to apportion deductions and W-2 wages ratably between income related to qualified payments and income not related to qualified payments. This means, for example, that the amount of deductions in QBI allocable to qualified payments is equal to the proportion of the total deductions that the amount of income or gain related to qualified payments bears to total income or gain used to determine QBI. The same proportion also applies when determining the amount of W-2 wages allocable to the portion of the trade or business that received qualified payments. In addition to considering the specific comments concerning proposed § 1.199A-7(f)(2)(ii) described in this preamble, revisions necessary to clarify the scope and application of the safe harbor were made in § 1.199A-7(f)(2)(ii) of the final regulations.

Commenters requested clarification on whether QBI under the safe harbor allocation method in proposed § 1.199A-7(f)(2)(ii) includes: Gross receipts from the sale of farm equipment, farm program payments (

i.e.,

Conservation Reserve Program, Market Facilitation Program, Dairy Program, etc.), section 1245 recapture, and commonly owned rental income. One commenter recommended that gross receipts from the sale of equipment and machinery should be included in the calculation and allocated based on past depreciation (in

the case of section 1245 recapture), and that gross receipts from farm programs be considered not related to qualified payments. Another commenter recommended that both gains from section 1245 recapture, crop insurance receipts, government subsidy payments, and income from aggregated rental income under § 1.199A-4 be not allocable to qualified payments received from Specified Cooperatives for purposes of section 199A(b)(7).

Section 199A(b)(7)(A) requires determining the QBI with respect to a trade or business that is properly allocable to qualified payments received from a Specified Cooperative, § 1.199A-7(f)(2)(i) requires a reasonable method be adopted for making this determination, and the safe harbor under § 1.199A-7(f)(2)(ii) allows patrons under the threshold amount to allocate the deductions and W-2 wages of a business between income related to qualified payments and income that is not related to qualified payments based on a ratio. The determination of whether the amounts mentioned by commenters are included in QBI of a trade or business, subject to the section 199A(b)(7) reduction, and how these amounts are allocated may change based on a patron's individual facts and circumstances and is not addressed in the final regulations.

One commenter also requested that the safe harbor method in proposed § 1.199A-7(f)(2)(ii) apply to patrons with a trade or business that has average annual total gross receipts equal to $25,000,000 or less. This amount is equal to the threshold for the small business simplified overall method under proposed § 1.199A-10(f)(1). Under the small business simplified overall method, a qualifying small Specified Cooperative may apportion total costs for the current taxable year between domestic production gross receipts (DPGR) and non-DPGR based on relative gross receipts for purposes of calculating the section 199A(g) deduction. The safe harbor in proposed § 1.199A-7(f)(2)(ii) is different from the safe harbor in proposed § 1.199A-10(f)(1). Proposed § 1.199A-7(f)(2)(ii) is applied as part of the patron's calculation of the section 199A(a) deduction. In calculating the section 199A(a) deduction, the threshold amount (described in section 199A(e)(2)) is used in other circumstances to determine when a taxpayer must engage in more complex calculations, specifically the W-2 wage and UBIA of qualified property limitations in section 199A(b)(2)(B). Thus, it is consistent with section 199A(e)(2) for the safe harbor in proposed § 1.199A-7(f)(2)(ii) to adopt the threshold amount. This contrasts with the small business simplified overall method in § 1.199A-10(f)(1), used to compute the section 199A(g) deduction by a Specified Cooperative, and for which the threshold amount in section 199A(e)(2) is not relevant. Therefore, the final regulations do not adopt this request.

The commenter also suggested cooperative and noncooperative farming expenses should be allocable based on sales. The commenter believes that if an allocation based on sales is not allowed, then it will be impossible for cash basis taxpayers to offset input expenses from the prior year to harvest revenues in the following year, because taxpayers would have already claimed the expenses in the prior year. Moreover, because farmers do not know if crops are sold to a Specified Cooperative or noncooperative until the crops are harvested, the potential exists for allocations to be understated/overstated as it relates to either Specified Cooperative/noncooperative revenues. The reasonable method approach in § 1.199A-7(f)(2)(i) of the Proposed Regulations, which is the approach adopted in the final regulations, accommodates these timing issues. A reasonable method is based on the facts and circumstances of the taxpayer and should provide the needed flexibility to accommodate this fact pattern.

D. Comments on Examples in Proposed § 1.199A-7(g)

Commenters requested corrections to proposed § 1.199A-7(g)(1), Example 1, because the allocation of W-2 wage expense is not proportional to the total expense allocation. This example illustrates that a reasonable method of allocation does not necessarily have to be proportional between W-2 wages and other expenses. This example is consistent with Example 1 in the Joint Committee Report. The Joint Committee Report in footnote 133 explains that example and the general rule by stating that “[w]hich expenses are properly allocable in a given case will depend on all the facts and circumstances. The example assumes that the fraction of properly allocable W-2 wages differs from the fraction of other properly allocable expenses.” Thus, a modification to the allocation in Example 1 of the proposed § 1.199A-7(g)(1) is not warranted.

II. § 1.199A-8, Deduction for Income Attributable to Domestic Production Activities of Specified Cooperatives

A. In General

Section 199A(g) provides a deduction for Specified Cooperatives and their patrons. This deduction is similar in many respects to the former section 199 deduction and, as provided in section 199A(g)(6), these regulations are based on the regulations applicable to Specified Cooperatives and their patrons under former section 199. The section 199A(g) deduction is calculated by the Specified Cooperative and is equal to 9 percent of the lesser of the Specified Cooperative's QPAI or taxable income (as modified by section 199A(g)(1)(C)) for the taxable year. There is a further limitation on the deduction equal to 50 percent of the Specified Cooperative's W-2 wages for the taxable year that are properly allocable to DPGR. Proposed § 1.199A-8 provides definitions relating to the section 199A(g) deduction, which includes establishing the criteria that a Specified Cooperative must satisfy to be eligible to claim the section 199A(g) deduction, and sets forth the necessary steps for a Specified Cooperative to calculate the section 199A(g) deduction. This part II.A provides a general outline of proposed § 1.199A-8, and the remainder of this part II addresses specific comments on proposed § 1.199A-8. Other than as described in response to the specific comments, the final regulations generally follow the Proposed Regulations.

Proposed § 1.199A-8(a), for purposes of section 199A(g), defines the terms patron (cross references proposed § 1.1388-1(e)), Specified Cooperative, and agricultural or horticultural products. The definition of Specified Cooperative is consistent with section 199A(g)(4) and the Joint Committee Report, and reflects the 2018 Act's amendment to the definition originally provided by section 11011(a) of the TCJA.; that is, a Specified Cooperative no longer includes a Cooperative solely engaged in the provision of supplies, equipment, or services to farmers or other Specified Cooperatives. The definition of agricultural or horticultural products in the Proposed Regulations is based upon the Cooperative Marketing Act of 1926, 44 Stat. 802 (1926).

Proposed § 1.199A-8(b) provides the four steps a Specified Cooperative that is not qualified as a farmer's cooperative organization under section 521 (nonexempt Specified Cooperative) performs to calculate its section 199A(g) deduction and includes definitions of relevant terms. Step 1, under proposed

§ 1.199A-8(b)(2)(i), requires a Specified Cooperative to identify its patronage and nonpatronage gross receipts, and related cost of goods sold (COGS), deductible expenses, W-2 wages, etc. (collectively, deductions) and allocate these deductions to the gross receipts from patronage and nonpatronage activity. Proposed § 1.199A-8(b)(2)(ii) directs a nonexempt Specified Cooperative to use only patronage gross receipts and related deductions when calculating the section 199A(g) deduction. Step 2, under proposed § 1.199A-8(b)(3), requires a nonexempt Specified Cooperative to determine the patronage gross receipts that qualify as DPGR. Proposed § 1.199A-9 provides rules for determining whether gross receipts are DPGR. Step 3, under proposed § 1.199A-8(b)(4), requires a Specified Cooperative to calculate QPAI (including oil-related QPAI) from only patronage DPGR and patronage deductions. Further rules for allocating COGS and other expenses, losses, or deductions to patronage DPGR are in proposed § 1.199A-10. A nonexempt Specified Cooperative calculates the section 199A(g) deduction using step 4, under proposed § 1.199A-8(b)(5). Proposed § 1.199A-8(b) also provides a definition of taxable income (including how to take net operating losses (NOLs) into account), rules on the use of the patronage section 199A(g) deduction, and special rules for nonexempt Specified Cooperatives that have oil-related QPAI.

Proposed § 1.199A-8(c) provides rules explaining the steps a Specified Cooperative that is qualified as a farmer's cooperative organization under section 521 (exempt Specified Cooperative) performs to calculate its section 199A(g) deduction. Generally, exempt Specified Cooperatives follow the same steps as nonexempt Specified Cooperatives, except that exempt Specified Cooperatives are not disallowed a section 199A(g) deduction based on nonpatronage gross receipts and related deductions. Instead, exempt Specified Cooperatives performs step 1 to identify patronage and nonpatronage gross receipts and related deductions, and then performs steps 2 through 4 in proposed § 1.199A-8(b) twice, to calculate a patronage section 199A(g) deduction and a nonpatronage section 199A(g) deduction. Proposed § 1.199A-8(c)(4)(ii) explains that the nonpatronage section 199A(g) deduction can be used only against nonpatronage income and cannot be passed through to patrons.

Proposed § 1.199A-8(d) provides rules for Specified Cooperatives passing through the section 199A(g) deduction to patrons. In general, under proposed § 1.199A-8(d)(1), a Specified Cooperative may pass through all, some, or none of the section 199A(g) deduction to patrons who are eligible taxpayers as defined in section 199A(g)(2)(D), that is, (i) a patron that is other than a corporation defined in section 1361(a)(2) (C corporation) or (ii) a patron that is a Specified Cooperative. Proposed § 1.199A-8(d)(2) limits the amount of the section 199A(g) deduction that a Specified Cooperative can pass through to the portion of the section 199A(g) deduction that is allowed with respect to the QPAI to which the qualified payments (defined in proposed § 1.199A-8(d)(2)(ii)) made to the eligible taxpayer are attributable. Proposed §§ 1.199A-8(d)(3) through (7) further outlines the written notice requirement to pass through the deduction to a patron, the patron's ability to deduct the section 199A(g) passed through (generally limited to the patron's taxable income), that a Specified Cooperative that is passed through a section 199A(g) deduction as an eligible taxpayer is limited to taking the deduction only against patronage gross income and related deductions, that the W-2 wage limitation is applied only at the Specified Cooperative level, and that a Specified Cooperative must reduce its section 1382 deduction by an amount equal to the section 199A(g) deduction passed through to its eligible patrons.

The remainder of proposed § 1.199A-8 covers a variety of issues. Proposed § 1.199A-8(e) provides examples that illustrate the rules in proposed § 1.199A-8(b) through (d). Proposed § 1.199A-8(f) provides guidance for Specified Cooperatives that are partners in a partnership. Proposed § 1.199A-8(g) provides guidance on the recapture of a claimed section 199A(g) deduction. Finally, proposed § 1.199A-8(h) generally provides that taxpayers may rely on the proposed rules in their entirety and as applied in a consistent manner until final regulations are published in the

Federal Register

.

B. Comments Related to Definition of “Agricultural or Horticultural Products”

i. General Comments on Definition

Section 199A(g)(3)(D) defines DPGR as the gross receipts of a taxpayer that are derived from any lease, rental, license, sale, exchange, or other disposition (collectively, disposition) of any agricultural or horticultural product that was manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or significant part within the United States. Proposed § 1.199A-8(a)(4) defines

agricultural or horticultural products

as agricultural, horticultural, viticultural, and dairy products, livestock and the products thereof, the products of poultry and bee raising, the edible products of forestry, and any and all products raised or produced on farms and processed or manufactured products thereof within the meaning of the Cooperative Marketing Act of 1926, 44 Stat. 802 (1926). Agricultural or horticultural products also include aquatic products that are farmed whether by an exempt or a nonexempt Specified Cooperative. In addition, agricultural or horticultural products include fertilizer, diesel fuel, and other supplies used in agricultural or horticultural production that are MPGE by a Specified Cooperative. Agricultural or horticultural products, however, do not include intangible property (other than as provided in the exception in § 1.199A-9(b)(2)); for example, an agricultural or horticultural product includes a seed that is grown, but does not include the intangible property right to reproduce a seed for sale. This exclusion of intangible property does not apply to intangible characteristics of any particular agricultural or horticultural product. For example, gross receipts from the sale of different varieties of oranges would all qualify as DPGR from the disposition of agricultural or horticultural products (assuming all other requirements of section 199A(g) are met). However, gross receipts from the license of the right to produce and sell a certain variety of an orange would be considered separate from the orange and not from an agricultural or horticultural product.

One commenter requested that the definition be omitted on the premise that the meaning of farming and agricultural or horticultural product is generally understood by the agricultural community and their advisors, and argued that there was no current, comprehensive definition of these terms in the Code or regulations. Because section 199A(g) is focused solely on dispositions of agricultural or horticultural products, as opposed to the broader scope of former section 199, the Treasury Department and the IRS have determined a definition is necessary to provide guidance on the limits of the section 199A(g) deduction. As an alternative to removing the definition, the commenter recommended against referencing non-tax legislation or regulations because the definitions were developed independent of tax law. The Treasury Department and the IRS have determined that using

the definition from the Proposed Regulations, based on a pre-existing definition from non-tax cooperative law specifically referencing the type of cooperative at issue here, is the best alternative, but have made some modifications based on the commenter's suggested definition. The definition in the final regulations includes parts of the commenter's suggested definition, by providing examples (without limitation) of products that are considered agricultural or horticultural products, including specific agricultural or horticultural products, livestock products, edible forestry products, and farmed aquatic products.

ii. Comments on Exclusion of Intangible Property

A commenter requested that the definition of agricultural or horticultural products include intangible property. The commenter reasoned that because a license is a disposition under section 199A(g)(3)(D) for purposes of determining if gross receipts qualify as DPGR, an exploitation of intangible property is implied. However, the inclusion of the term license under section 199A(g)(3)(D) does not impact the definition of agricultural or horticultural products. The term license also appeared in former section 199(c)(4)(A)(i), which was the equivalent of section 199A(g)(3)(D) under former section 199. Under former section 199, DPGR generally meant the gross receipts of the taxpayer derived from qualifying production property (QPP) which was MPGE by the taxpayer in whole or significant part within the US. Income from the disposition of intangible property (with the specific exception of computer software, sound recordings under section 168(f)(4), and qualified films under former section 199(c)(6)) were generally excluded from DPGR. This was because intangible property was not QPP (as defined in former section 199(c)(5), also see former § 1.199-3(j)(2)(iii)). The proposed definition and rules reach a similar result for purposes of section 199A(g).

Also related to intangible property, the commenter specifically requested that gross receipts qualify as DPGR from the disposition of an agricultural or horticultural product when a Specified Cooperative enters into a long-term arrangement with an unrelated third party, under which (1) the Specified Cooperative develops a finished retail product with the unrelated third party, (2) the finished retail product contains a patron's product as an ingredient, and (3) the Specified Cooperative receives a royalty or license fee based on the sale of the finished retail product irrespective of whether the Specified Cooperative's brand, label, and/or tradename is featured on the finished retail product. The situation described by the commenter is very fact specific and raises multiple possible issues for purposes of section 199A(g). Among the issues to consider are what property or properties the Specified Cooperative is deriving gross receipts from in the normal course of business, and which party is the producer of the property. Because of the fact specific nature of the comment, and multiple possible outcomes, there is no rule or example to address this specific situation in the final regulations.

After consideration of the comments, the final regulations maintain the approach in the Proposed Regulations that the definition of agricultural or horticultural products does not include intangible property, but also provide language further clarifying the exclusion. The clarifying language provides that intangible rights include the rights to MPGE and sell an agricultural or horticultural product with certain characteristics protected by a patent and the trademark of a brand. Further examples 9 and 10 have been added to § 1.199A-8(e) to illustrate concepts related to intangible property transactions and the disposition of agricultural or horticultural products.

iii. Comments on “Other Supplies”

Included in the definition of agricultural or horticultural products are other supplies that are MPGE by the Specified Cooperative. A commenter suggested that the MPGE requirement be removed from “other supplies” on the basis that Joint Committee Report footnote 120 cites § 1.199-6(f), which made no mention of a MPGE requirement as it pertained to “other supplies” being agricultural or horticultural products. However, footnote 120 explicitly mentions a MPGE requirement as it pertains to other supplies. The Joint Committee Report also explains that after the amendments to section 199A(g) made by the 2018 Act, “[t]he definition of [specified agricultural or horticultural cooperative] no longer includes a [C]ooperative solely engaged in the provision of supplies, equipment, or services to farmers or other specified agricultural or horticultural cooperatives.” Joint Committee Report, 23. Based upon these considerations, subjecting “other supplies” to a MPGE requirement before being considered agricultural or horticultural products is appropriate.

Commenters also requested that “other supplies” be further illustrated with examples. The final regulations include more examples of “other supplies” such as seed, feed, herbicides, and pesticides.

Finally, one commenter requested that language be added to the definition of agricultural or horticultural products to include supplies used in activities under § 1.199A-9(f)(2) and (3). Under proposed § 1.199A-9(f)(2) and (3), if the Specified Cooperative performs packaging, repackaging, labeling, or installation with respect to an agricultural or horticultural product and engages in no other MPGE activity with respect to that agricultural or horticultural product, the Specified Cooperative's activity does not qualify as MPGE with respect to that agricultural or horticultural product. Based on this rule, to the extent a Specified Cooperative performs MPGE activities with respect to an agricultural or horticultural product, and in conjunction performs a packaging, repackaging, labeling, or installation activity, the activities are treated as part of the MPGE of the agricultural production. The packaging or labeling materials used may also be treated as part of the agricultural or horticultural product. For example, if a Specified Cooperative packages an agricultural or horticultural product that the Specified Cooperative had MPGE, then the packaging activity is treated as part of the MPGE of the agricultural or horticultural product, and gross receipts from the sale of the packaged agricultural or horticultural product all qualify as DPGR, assuming all other requirements for such treatment are met. However, property packaged or offered with an agricultural or horticultural product that is not an agricultural or horticultural product (or packaging) is not considered part of the agricultural or horticultural product.

C. Identifying Patronage Items and Exclusion of Nonpatronage Items for Nonexempt Specified Cooperatives

As previously described, proposed § 1.199A-8(b) outlines a four-step process for nonexempt Specified Cooperatives to use in calculating the section 199A(g) deduction. Step 1, in proposed § 1.199A-8(b)(2)(i) and (ii), requires a nonexempt Specified Cooperative to identify its gross receipts, COGS, deductions, W-2 wages, etc. as patronage or nonpatronage, and allows only the patronage activities to be included in the calculation of the section 199A(g) deduction. One commenter described step 1 as burdensome and unnecessary, and suggested removal of that step. Further, the commenter asserted that both

patronage and nonpatronage activities should be included in the section 199A(g) deduction calculation for nonexempt Specified Cooperatives. The commenter provided, as an alternative to removal of that step, that these rules be reserved until the conclusion of litigation under former section 199 relating to the calculation of the former section 199 deduction by Specified Cooperatives.

The Treasury Department and the IRS decline to adopt these comments in the final regulations for the reasons described in the following paragraphs. However, the final regulations make revisions to the proposed regulations to benefit and reduce complexity for Specified Cooperatives with de minimis gross receipts from nonpatronage activities.

Section 199A(g)(4)(A) defines a Specified Cooperative, in part, as an organization to which part I of subchapter T applies. Under section 1381(a)(2), subchapter T applies to any corporation operating on a cooperative basis, with certain exceptions not relevant here. In the commenter's view, this means that if subchapter T applies, it applies to the entire corporation, and the benefits of the section 199A(g) deduction should follow that determination. In support of this position, the commenter argues that the plain language of the statute and the Joint Committee Report do not limit the deduction to patronage activities. The commenter's view fails to properly take into account how subchapter T applies to nonexempt Cooperatives that have both cooperative and noncooperative operations. This is an especially important consideration because of the exclusion of C corporations from the definition of eligible taxpayers under section 199A(g)(2)(D)(i), and the fact that section 199A as a general matter is not intended to benefit C corporations.

When a nonexempt Cooperative does not act entirely on a cooperative basis under subchapter T, its activities are characterized as patronage or nonpatronage, and accordingly, the tax items from these distinct activities receive different treatment.

See Buckeye Countrymark, Inc.

v.

Comm'r,

103 T.C. 547, at 559 (1994) (explaining that “subchapter T requires nonexempt cooperatives to separate income and deductions into two categories or baskets, one for patronage income and deductions and one for nonpatronage income and deductions”) and

Farm Service Coop.

v.

Comm'r,

619 F.2d 718 (8th Cir. 1980) (subchapter T prohibits the netting of patronage losses against nonpatronage income). Cooperative activities generate patronage income and deductions and are taxed on a cooperative basis, generally resulting in a single-level of tax to the Cooperative or the patrons after application of the rules under subchapter T.

See

Joint Committee Report, 20 (explaining that “excluding patronage dividends and per-unit retain allocations paid by the cooperative from the cooperative's taxable income in effect allows the cooperative to be a conduit with respect to profits derived from transactions with its patrons”). In contrast, noncooperative activities of a Cooperative generate nonpatronage income and deductions and are taxed like a for-profit business of a C corporation, resulting in a double-level of tax, that is, at both the Cooperative and patron levels.

See, for example,

Farm Service

at 723, and

Conway Cty. Farmers Ass'n

v.

United States,

588 F.2d 592, 596 (8th Cir. 1978) (describing nonpatronage income as being taxed as a for-profit business in case where organization found to be operating on a cooperative basis with more than 50 percent of business done with nonmembers).

There is limited guidance as to how much of an organization's activities must be conducted on a cooperative basis for the organization to qualify as a Cooperative under subchapter T, but the available guidance suggests a low threshold in certain cases. To the extent this is true, it allows for the noncooperative activities to be of substantial value relative to the organization's cooperative activities. For example, in

Columbus Fruit and Vegetable Coop. Ass'n, Inc.

v.

United States,

7 Cl. Ct. 561 (March 27, 1985), the court held that an agricultural organization whose sales of members' merchandise accounted for only about 24 percent of value of its total sales for the tax years in question was nevertheless a corporation operating on a cooperative basis within the meaning of the Code, and thus was entitled to deduct patronage dividends paid to its members.

The Treasury Department and IRS compared how application of the rules of subchapter T aligned with the commenter's proposal and with the Proposed Regulations and found the subchapter T rules align better with the Proposed Regulations. Among the scenarios considered were C corporations engaged in the following: (1) An agricultural business with no cooperative activities (scenario 1); (2) an agricultural business operating entirely on a cooperative basis considered a nonexempt Specified Cooperative (scenario 2); and, (3) an agricultural business with a mixed percentage of business from cooperative and noncooperative activities that qualifies as a nonexempt Specified Cooperative (scenario 3).

In the first and second scenarios, both the commenter's proposal and the Proposed Regulations reach the same conclusions. In the first scenario, because none of the organization's activities are conducted on a cooperative basis, subchapter T does not apply to the organization, and the organization receives no benefits from the section 199A(g) deduction. In the second scenario, because all the organization's activities are conducted on a cooperative basis, the benefits of subchapter T apply to all of the organization's activities, and the organization can calculate the section 199A(g) deduction based on all its activities.

It is the third scenario where the conclusions under the commenter's proposal and the Proposed Regulations differ. Under the commenter's proposal, subchapter T applies to the organization and so the organization should calculate a single section 199A(g) deduction by aggregating the patronage income, deductions, etc., resulting from cooperative activities and the nonpatronage income, deductions, etc., resulting from noncooperative activities. The commenter's proposal would permit a Specified Cooperative to calculate and take the section 199A(g) deduction on its business activities that are not operated on a cooperative basis (those activities that generate income that is taxed as that of a C corporation). This would be the case even where a substantial portion of the income of the Specified Cooperative is generated from business activities not operated on a cooperative basis. In contrast, the Proposed Regulations allow the organization to calculate the section 199A(g) deduction based only on the patronage income, deductions, etc., resulting from the organization's cooperative activities.

The Proposed Regulations, and not the commenter's proposal, align with subchapter T and the structure and intent of section 199A. Under subchapter T, a nonexempt Cooperative with both cooperative and noncooperative activities receives beneficial single-level tax treatment only on its patronage income, and its income from operating as a C corporation (that is, nonpatronage income) receives double-level tax treatment.

Farm Service

at 723. Generally, section 199A was structured to give businesses that are not operating as C corporations a deduction that corresponds to the TCJA's reduction of

the top corporate rate of tax from 35 percent to 21 percent under section 11. Indeed, Congress needed to specifically clarify that Specified Cooperatives could benefit from the section 199A deduction because Cooperatives are C Corporations. See section 1382(a)(2). That is, Congress, in including section 199A(g), was making sure that Specified Cooperatives received a benefit when operating as Cooperatives. This also makes sense when considering that patronage distributions deductible under section 1382 to a Specified Cooperative, which enable the Specified Cooperative to act as a conduit for its patrons, are taxed to the patrons eligible for the section 199A(a) deduction at individual rates. The Proposed Regulations align with this intent because only the activities resulting in patronage income receive beneficial treatment under section 199A(g), and income arising from nonpatronage activities continues to be taxed as income from a C corporation. Were the result as requested by commenter, a C corporation conducting a portion of its business on a cooperative basis would receive the benefits of both the reduced corporate income tax rate and the section 199A(g) deduction with respect to its nonpatronage activities, giving it a competitive advantage relative to a regular C corporation.

The commenter also referred to section 199A(g)(6), which provides that the Secretary shall prescribe regulations as are necessary to carry out the purposes of section 199A(g), and that the regulations shall be based on the regulations applicable to Cooperatives and their patrons under section 199 (as in effect before its repeal). The commenter noted that the former section 199 regulations did not exclude nonpatronage income from the calculation of the former section 199 deduction. However, because there are material differences between former section 199 and section 199A, section 199A(g)(6) does not require that the section 199A(g) regulations replicate or duplicate the former section 199 regulations in their entirety. The former section 199 regulations did not specifically address an organization with cooperative and noncooperative operations because former section 199 applied to all categories of businesses, including C corporations, whether operating on a cooperative basis, noncooperative basis, or both. In contrast to the former section 199 deduction, the section 199A(g) deduction, which must be read in the context of section 199A, does not apply to C corporations generally. Unlike for the former section 199 regulations, clarification of this distinction is necessary to carry out the purposes of section 199A(g), which include providing the section 199A(g) deduction for the patronage activities of Specified Cooperatives. Clarification of this distinction is also necessary to assist taxpayers in complying with the law, as well as to aid the proper administration of section 199A(g).

The Treasury Department and the IRS also considered the recent opinions in

Ag Processing, Inc.

v.

Comm'r,

153 T.C. No. 3 (2019), and

Growmark, Inc. & Subsidiaries

v.

Comm'r,

T.C. Memo. 2019-161. These cases are the litigation referred to by the commenter. In

Ag Processing

and

Growmark,

the Tax Court determined that under former section 199, a nonexempt agricultural Cooperative should calculate the section 199 deduction in the aggregate by combining patronage and nonpatronage items and then allocating the total section 199 deduction between the Cooperative's patronage and nonpatronage businesses. These cases do not support, and in fact, conflict with the commenter's proposal in that they require an allocation of the former section 199 deduction between patronage and nonpatronage businesses. At the same time, the Tax Court's approach in these cases allows the proceeds of the cooperative and noncooperative businesses to be combined to calculate an aggregate deduction before allocation. The allowance of an aggregate calculation highlights the difference between section 199A(g), benefitting solely cooperative activities, and former section 199, benefitting both cooperative and noncooperative activities. Thus, the cases do not necessitate that final regulations adopt an approach different from that of the Proposed Regulations. Based on the commenter's proposal, the Treasury Department and IRS considered calculating the section 199A(g) deduction on an aggregate basis and then disallowing the nonpatronage portion, but this would require unnecessary calculations and likely prove less accurate than the straightforward calculation provided in the Proposed Regulations.

Finally, the Treasury Department and IRS considered how the commenter's proposal would align with the treatment of exempt Specified Cooperatives. The commenter's proposal would allow both exempt and nonexempt Specified Cooperatives to calculate their section 199A(g) deductions based on both cooperative and noncooperative activities. The Proposed Regulations permit only exempt Specified Cooperatives to calculate their section 199A(g) deductions based on both cooperative and noncooperative activities. Under subchapter T, exempt Cooperatives can receive the beneficial single-level tax treatment with respect to both types of business activities while nonexempt Cooperatives cannot. In effect, by meeting the requirements of section 521, the entirety of an exempt organization's operations can be treated as done on a cooperative basis. Exempt Specified Cooperatives, thus, are effectively equivalent to the described scenario 2 (a nonexempt Specified Cooperative operating entirely on a cooperative basis). The commenter's proposal would provide the same benefits of the section 199A(g) deduction to nonexempt Specified Cooperatives without requiring those Cooperatives to meet the requirements of section 521.

In summary, the Treasury Department and the IRS have determined that retaining step 1 in proposed § 1.199A-8(b)(2)(i) and (ii) is the approach for calculating the section 199A(g) deduction that best reflects the law and is most consistent with the scope of section 199A(g) and the application of subchapter T to nonexempt Cooperatives.

The final regulations, however, revise the rule for applicable gross receipts in § 1.199A-8(b)(2)(ii) to allow a Specified Cooperative to include all nonpatronage gross receipts in non-DPGR for purposes of the de minimis rules in § 1.199A-9(c)(3), while also increasing the de minimis percentage in the de minimis rules in § 1.199A-9(c)(3) from 5 percent to 10 percent. These revisions expand the type of gross receipts eligible for the de minimis rules and should increase the number of Specified Cooperatives that can apply the de minimis rules. Applying the de minimis rule in § 1.199A-9(c)(3)(i) after these revisions means that a Specified Cooperative when calculating its patronage section 199A(g) deduction can treat all of its gross receipts as DPGR when the Specified Cooperative derives less than 10 percent of its total gross receipts from non-DPGR (with non-DPGR now possibly including all gross receipts from nonpatronage as well as other patronage non-DPGR). While this provides the benefit of increased DPGR, application of the de minimis rule in § 1.199A-9(c)(3)(i) also reduces complexity by simplifying the allocations needed to calculate the section 199A(g) deduction. Under § 1.199A-9(c)(3)(ii), the revisions also make it possible for any Specified Cooperative deriving less than 10 percent of their gross receipts from

DPGR to treat all of their gross receipts as non-DPGR. The final regulations also update § 1.199A-8(b)(5)(ii)(C), § 1.199A-8(c)(2) and (4), and § 1.199A-12(b)(1) to take these revisions into account.

D. Exempt Specified Cooperative Calculation of Nonpatronage Section 199A(g) Deduction

Rules for exempt Specified Cooperatives to calculate the section 199A(g) deduction were included in proposed § 1.199A-8(c). Specifically, under proposed § 1.199A-8(c)(2), an exempt Specified Cooperative calculates separate patronage and nonpatronage section 199A(g) deductions, as is consistent with the administration of former section 199. One commenter disputed that separate calculations were required under former section 199 and further stated that separate calculations are unnecessary since exempt Specified Cooperatives are permitted the section 199A(g) deduction on both their patronage and nonpatronage income. Contrary to the commenter's assertion, the instruction to line 25 for Agricultural and Horticultural Cooperatives on the Form 8903, Domestic Production Activities Deduction, makes clear that the calculations are made separately. This step is necessary because allowing an aggregate calculation and allocation results in less accurate patronage and nonpatronage deductions because alignment of the appropriate W-2 wages, COGS, and other expenses from an activity with the income from that activity is lost on aggregation, and difficult to rectify on allocation. For these reasons, the final regulations maintain the requirement of separate calculations of the patronage section 199A(g) deductions and nonpatronage section 199A(g) deductions by exempt Specified Cooperatives. However, the revisions in the final regulations to § 1.199A-8(b)(2)(ii) and the increase in the de minimis percentage under § 1.199A-9(c)(3) will simplify the allocations needed to calculate the section 199A(g) deduction for an exempt Specified Cooperative with de minimis nonpatronage gross receipts.

E. Definition of Taxable Income

i. General Definition Comments

Proposed § 1.199A-8(b)(5)(ii)(C) provides that taxable income is defined in section 1382 and § 1.1382-1 and § 1.1382-2. For purposes of determining the amount of the deduction allowed under § 1.199A-8(b)(5)(ii), taxable income is limited to taxable income and related deductions from patronage sources. Patronage NOLs reduce taxable income. Taxable income is determined without taking into account the section 199A(g) deduction or any deduction allowable under section 1382(b). Further, taxable income is determined using the same method of accounting used to determine distributions under section 1382(b) and qualified payments to eligible taxpayers.

One commenter stated that the definition of taxable income should refer to section 63, and take into account both patronage and nonpatronage income (including NOLs) on an aggregate basis. The Treasury Department and the IRS agree that section 63 generally defines taxable income. In response, the definition of taxable income in the final regulations has been modified so that it also includes a reference to section 63. However, consistent with the exclusion of nonpatronage items from the calculation of the section 199A(g) deduction, the final regulations continue to limit the definition to patronage taxable items for purposes of the limitation.

The commenter also stated that the requirement that Specified Cooperatives use the same method of accounting to determine taxable income, distributions under section 1382(b), and qualified payments is in error. Specifically, commenter stated that patronage dividends or other similar payments to patrons can be calculated on a book basis because it is a more accurate economic measure of income over time. The commenter provided an example where accelerated depreciation and other book/tax items often cause timing differences that may disproportionately benefit longer-term patrons over shorter-term patrons. Commenter further maintained that Cooperatives have been allowed to determine payments to patrons pursuant to methods other than on tax basis. The commenter pointed to section 1388(a)(3), which in defining patronage dividends, references the net earnings of the organization. In the commenter's view, the use of net earnings rather than taxable income means that net earnings do not necessarily correlate to taxable income. Further, the commenter pointed to Example 2 of former § 1.199-6(m) that included language indicating patronage distributions could be paid based on book or Federal income tax net earnings, as well as the requirement on Form 1120-C (U.S. Income Tax Form for Cooperative Associations) that a cooperative disclose the method of accounting used to compute distributable patronage income, with the choices being “Book,” Tax,” and “Other.”

In reviewing this part of the definition, the Treasury Department and the IRS determined it is unnecessary for defining taxable income to include the requirement that taxable income is determined using the same method of accounting used to determine distributions under section 1382(b) and qualified payments to eligible taxpayers. Accordingly, the final regulations do not include this requirement in § 1.199A-8(b)(5)(ii)(C) and also do not include a similar requirement in § 1.199A-8(c)(4)(i). The commenter's example and reasoning, however, relate more to the deductibility under section 1382 of distributions to patrons calculated on a book basis when there are book/tax differences, which is outside of the scope of the final regulations. No inference as to the deductibility of distributions to patrons under section 1382 is intended by removing this language (regardless of the method used to determine the payments).

ii. Comments on Net Operating Loss (NOL) Ordering Rules

Proposed § 1.199A-8(b)(5)(ii)(C) provides that patronage NOLs reduce taxable income. However, taxable income does not take into account the section 199A(g) deduction or any deduction allowable under section 1382(b). A commenter requested clarification on ordering rules concerning the interplay of NOLs, section 1382(b), and section 199A(g) deductions. Specifically, the commenter requested that final regulations clarify that the amount of an NOL that is taken into account for purposes of calculating the section 199A(g) deduction is the amount that the Specified Cooperative actually used in computing taxable income on its tax return for the year. The commenter further suggested that NOLs should not be regarded as having been used against any patronage dividends or per-unit retain allocations that are disregarded in computing taxable income for purposes of the section 199A(g) deduction limitation. The commenter provided an example where a nonexempt Specified Cooperative generated $100 of QPAI and taxable income, without taking account any of its deductions under section 1382(b) or section 199A(g), or an NOL carryover of $500. In the commenter's example, the nonexempt Specified Cooperative was able to calculate and use a $9 section 199A(g) deduction, pay out a $91 patronage dividend, and avoid using any of the $500 NOL carryover.

In consideration of the commenter's example, the Treasury Department and

the IRS reviewed Examples 1 and 2 in former § 1.199-1(b)(2), which illustrated that when calculating and using the former section 199 deduction, taxable income is reduced by any available NOL or NOL carryovers, before being reduced by the section 199 deduction. This avoided having the former section 199 deduction create or increase an NOL, but did not illustrate how section 1382 deductions impacted the calculation or use of the former section 199 deduction. Consistent with former section 199, taxable income for purposes of calculating the section 199A(g) deduction should take into account an NOL or NOL carryover. After calculation, the section 199A(g) deduction should not create or increase an NOL or NOL carryover. The section 199A(g) deduction also should not be used as a substitute for an NOL carryover when a Specified Cooperative has taxable income remaining after its section 1382 deductions, but before the section 199A(g) deduction is taken.

Using the facts of the commenter's example, this means that for purposes of calculating the section 199A(g) deduction, the $500 NOL carryover should reduce taxable income by $9, which is the amount that remains after the section 1382(b) deduction. Taxpayer would calculate a section 199A(g) deduction based on $91 (the lesser of QPAI ($100) or taxable income ($91), without taking section 1382(b) deduction into account). As a result under these facts, taxpayer would have $0 of taxable income after taking a section 1382 deduction of $91 and using $9 of the $500 NOL carryover (leaving a $491 NOL carryover). The Specified Cooperative could pass through the section 199A(g) deduction to patrons and reduce its section 1382 deduction accordingly. However, if the Specified Cooperative did not pass through the section 199A(g) deduction it would be lost because the deduction cannot increase an NOL carryover. In accordance with this analysis, the definition of taxable income in § 1.199A-8(b)(5)(ii)(C) and the rules in § 1.199A-8(b)(6) related to a Specified Cooperative using the section 199A(g) deduction have been updated. To illustrate this ordering rule, example 5 has also been added under § 1.199A-8(e). Based on this ordering rule and its reasoning, the Treasury Department and the IRS decline to adopt the commenter's approach permitting Specified Cooperatives to reduce taxable income by taking the section 199A(g) deduction before using an NOL, but clarify that NOLs are not used against taxable income that is the result of not taking into account section 1382 deductions when calculating the section 199A(g) deduction.

The commenter also stated that the examples in the proposed regulation (Examples 6 and 7 of proposed § 1.199A-8(e)) do not consider the more realistic case where the Specified Cooperative made payments to patrons that were deductible under section 1382(b). The Treasury Department and the IRS agree with this statement, and the new example in § 1.199A-8(e) replaces those examples from the Proposed Regulations.

F. Pass Through of Section 199A(g) Deduction

Sections 1.199A-8(d)(1) and (2) of the Proposed Regulations allow a Specified Cooperative, at its discretion, to pass through all, some, or none of its patronage section 199A(g) deduction to an eligible taxpayer (

i.e.,

a patron other than a C Corporation or a patron that is a Specified Cooperative), but the amount passed through to any eligible taxpayer is limited to the allowable portion of the section 199A(g) deduction with respect to the QPAI to which the qualified payments made to the eligible taxpayer are attributable. The intent of the proposed rule was to allow the Specified Cooperative the benefit of retaining and using the amounts equal to the section 199A(g) deduction attributable to non-eligible taxpayers (who will not be able to use the deduction) at the Specified Cooperative level, even when the Specified Cooperative chooses to pass through all or some of the section 199A(g) deduction attributable to patrons that are eligible taxpayers. Consistent with section 199A(g)(2)(A)(ii), proposed § 1.199A-8(d)(3) provides that a Specified Cooperative must identify in a written notice the amount of the deduction passed through to an eligible taxpayer, and the notice must be mailed by the Specified Cooperative to the eligible taxpayer no later than the 15th day of the ninth month following the close of the taxable year of the Specified Cooperative. The 15th day of the ninth month coincides with the end of the payment period as described in section 1382(d).

Commenters asked that the final regulations clarify that a Specified Cooperative will not be penalized if it passes through information relating to a section 199A(g) deduction to a non-eligible taxpayer, and that the ultimate determination of whether the deduction that is passed through can be used is the responsibility of the patron. One of these commenters indicated that section 199A(g)(2)(A) does not require the Specified Cooperative to determine the eligibility of all of its patrons. The Treasury Department and the IRS recognize that it may be difficult for a Specified Cooperative to determine the eligibility status of all patrons, and agree that the ultimate determination of eligibility should be made at the patron level. Therefore, the final regulations provide that a Specified Cooperative may pass through all, some, or none of the section 199A(g) deduction to all patrons, with appropriate adjustments to the section 1382 deduction depending on the amount passed through, but that only eligible taxpayers may claim the section 199A(g) deduction that is passed through. In considering this comment, the Treasury Department and the IRS also considered proposed § 1.199A-8(d)(5), which provides special rules for eligible taxpayers that are Specified Cooperatives, and that provides a Specified Cooperative that receives a section 199A(g) deduction can take the deduction only against patronage gross income and related deductions. The final regulations clarify the rule to be consistent with the nonpatronage disallowance for nonexempt Specified Cooperatives and also provide that only an exempt Specified Cooperative can take a section 199A(g) deduction passed through from another Specified Cooperative if the deduction relates to the patron Specified Cooperative's nonpatronage gross income and related deductions.

In addition to requesting that Specified Cooperatives not be required to identify the eligibility of all patrons, commenters requested that if a Specified Cooperative does obtain the tax status of its patrons so as not to pass through the section 199A(g) deduction to an non-eligible taxpayer, then the Specified Cooperative should be allowed to retain and use the section 199A(g) deduction from patrons that are non-eligible taxpayers while passing through the section 199A(g) deduction to patrons that are eligible taxpayers, subject to the section 199A(g)(1)(A)(ii) limitation. The Treasury Department and the IRS intended this result in the Proposed Regulations and have revised § 1.199A-8(d)(1) to clarify that if a Specified Cooperative obtains the tax status of a patron that is an non-eligible taxpayer, the Specified Cooperative may retain the section 199A(g) deduction attributable to that patron, even when passing through the deduction to other patrons. Example 11 under § 1.199A-8(e) has also been added to illustrate allocation rules for situations in which a Specified Cooperative retains the

section 199A(g) deduction attributable to non-eligible taxpayers.

Another commenter also requested relief from the notice requirements in proposed § 1.199A-8(d)(3) in the event that a Specified Cooperative wishes to pass through the section 199A(g) deduction to patrons but does not send the notice before the payment period ends, or passes through an incorrect amount of the section 199A(g) deduction during the payment period. Specifically, the commenter asked if there is a way to issue a late notice or to void or otherwise reissue a notice after the payment period. The requirement of identifying the amount passed through during the payment period is from section 199A(g)(2)(A)(ii). Further, no administrative remedies of this type existed under former section 199. The former section 199 rules required the notice to be provided during the payment period, and this notice worked in conjunction with the recapture provision in former § 1.199-6(k) and the no-double counting rule in former § 1.199-6(l). Finally, the payment period is also used in determining whether a distribution is deductible under section 1382(b), so a consistent interpretation is appropriate. Thus, no changes were made with respect to this comment.

G. Comments on Definition of Qualified Payments

Section 199A(g)(2)(E) defines

qualified payment,

with respect to any eligible taxpayer, as any amount which is (i) described in section 1385(a)(1) or (3), (ii) received by the taxpayer from a Specified Cooperative, and (iii) is attributable to QPAI with respect to which a deduction is allowed to the Specified Cooperative under section 199A(g)(1). Proposed § 1.199A-8(d)(2)(ii) defines qualified payment as “any amount of a patronage dividend or per-unit retain allocation, as described in section 1385(a)(1) or (3) received by a patron from a Specified Cooperative that is attributable to the portion of the Specified Cooperative's QPAI, for which the cooperative is allowed a section 199A(g) deduction. For this purpose, patronage dividends include any advances on patronage and per-unit retain allocations include per-unit retains paid in money during the taxable year. A Specified Cooperative calculates its qualified payment using the same method of accounting it uses to calculate its taxable income.” The inclusion of advances on patronage and per-unit retains paid in money during the taxable year is consistent with the definition in former § 1.199-6(e).

The commenter asserted that when a Specified Cooperative's section 199A(g) deduction is W-2 wage-limited under section 199A(g)(1)(B), section 199A(g)(2)(E)(iii) requires qualified payments to reflect the limitation for purposes of the section 199A(b)(7) reduction. The commenter provided an example where the Cooperative's W-2 wage-limited section 199A(g) deduction is $50, but would have been $100 absent the W-2 wage limitation, and so the commenter proposed that only 50 percent of patronage dividends (or per-unit retain allocations) would be “qualified payments” under section 199A(g)(2)(E).

The definition of qualified payment in former section 199 and section 199A is almost identical. Under former section 199, the definition in section 199(d)(3)(E)(iii) provided that a qualified payment is an amount which is attributable to QPAI with respect to which a deduction is allowed to such cooperative under section 199(a). Section 199(A)(g)(2)(E)(iii) provides the same except that it refers to the deduction allowed to such cooperative under section 199A(g)(1). In former section 199, the amount allowed under former section 199(a) did not consider the W-2 wage limitation, which was in section 199(b). Section 199A(g)(1) is organized so that section 199A(g)(1)(A) is equivalent to former section 199(a) and section 199A(g)(1)(B) is equivalent to former section 199(b).

The Proposed Regulations interpreted the definition of qualified payment as referring to payments that relate to gross receipts that are allowable in the QPAI of a Specified Cooperative for which a deduction is allowed under section 199A(g)(1)(A). This is consistent with the language used in section 199A(g)(1)(A), which provides that there shall be allowed a deduction equal to 9 percent of the lesser of (i) QPAI of the taxpayer for the taxable year, or (ii) the taxable income of the taxpayer for the taxable year. As relevant, this language parallels former section 199(a). This interpretation is directly supported by Example 1 of the Joint Committee Report, which illustrates that payments to the patron are considered qualified payments for purposes of the section 199A(b)(7) reduction when the issuing Specified Cooperative's section 199A(g) deduction was W-2 wage-limited. This is also consistent with the regulations under former section 199, which did not have a proportionality rule for qualified payments. Therefore, the final regulations do not incorporate this comment.

Commenters also requested clarification that the definition of qualified payments does not include amounts paid to patrons by Specified Cooperatives with respect to activities that do not qualify as producing DPGR from the sale of agricultural or horticultural products. When gross receipts of a Specified Cooperative are non-DPGR, and thus, are not includable in QPAI, payments based on these amounts do not meet the definition of qualified payments. The Treasury Department and the IRS agree with this comment and view this as consistent with the interpretation of qualified payment described earlier, but do not consider additional regulatory language necessary to clarify this point.

Commenters also suggested that the last sentence of the definition, indicating that a Specified Cooperative calculates its qualified payment using the same method of accounting it uses to calculate its taxable income, was added in error and should be removed. This sentence was not in the definition of qualified payment in former § 1.199-6(e), and the Treasury Department and the IRS have removed the sentence for consistency with former § 1.199-6(e). Further, the definition of qualified payments already encompasses this concept with its references to patronage dividends and per-unit retain allocations, as a Specified Cooperative calculates patronage dividends and per-unit retain allocations when determining taxable income.

H. Comments on Examples in Proposed § 1.199A-8(e)

Commenters requested clarification on Examples 1 and 2 of proposed § 1.199A-8(e), asking how both examples are based on the same facts, but the payment in Example 1 is deemed a per-unit retain allocation, while the payment in Example 2 is deemed a purchase. Commenters indicated that without further explanation, the examples were confusing. Example 2 has been removed to eliminate any confusion as Example 1 is consistent with Example 1 from the Joint Committee Report. Example 1 has also been slightly modified for clarity and to more closely track Example 1 from the Joint Committee Report. In general, the determination of whether a payment is a per-unit retain allocation is made based on the definition in section 1388(f). Section 1388(f) defines per-unit retain allocations as any allocation, by an organization to which part I of subchapter T apples, to a patron with respect to products marketed for the patron, the amount of which is fixed without reference to the net earnings of the organization pursuant to an agreement between the organization and

the patron. Per-unit retain allocations are qualified payments (to the extent all other requirements are met) under the definition in § 1.199A-8(d)(2)(ii).

One commenter also requested clarification on whether it is possible for a Specified Cooperative and its patrons to contractually agree that a payment is not a qualified payment. The Treasury Department and the IRS believe that an agreement to treat a payment that otherwise meets the definition of qualified payment as something else would be inappropriate and ineffective. A payment meeting the definition of a qualified payment should be characterized as a qualified payment.

Commenters also asked that Examples 1-3 from former § 1.199-6(m) be included in the final regulations. Similar to Example 2 of proposed § 1.199A-8(e), the facts of Examples 1 and 2 from former § 1.199-6(m) both treat the Cooperative payments to patrons as purchases rather than per-unit retain allocations. In order to avoid confusion, the examples were modified to be consistent with Example 1 from the Joint Committee Report. The final regulations include Examples 1-3 from former § 1.199-6(m) as Examples 6, 7, and 8 under § 1.199A-8(e).

I. Comments on Rules for Specific Cooperative Partners in Proposed § 1.199A-8(f)

Under proposed § 1.199A-8(f), a Specified Cooperative that is a partner in a partnership must determine which Schedule K-1 allocations (

i.e.,

gross receipts and related deductions) qualify as DPGR and use the items to calculate its corresponding section 199A(g) deduction. A commenter noted that W-2 wages generated by the partnership should be passed on to the Specified Cooperative partner, relying on section 199A(f)(1)(A)(iii) and former § 1.199-5(b)(1)(i). The Treasury Department and the IRS agree and have amended § 1.199A-8(f) accordingly. Section 1.199A-8(f) of the final regulations also includes the share of COGS to maintain consistency with former § 1.199-5(b)(1)(i), which allowed for the allocation of COGS to partners.

A commenter also requested that if a partnership conducts MPGE activities that result in DPGR, then a Specified Cooperative partner in that partnership should be treated as if the activities were directly conducted by the Specified Cooperative. The Treasury Department and IRS agree with the comment and § 1.199A-8(f) now allows for two-way attribution, meaning: (1) A partnership's activities alone with respect to an agricultural or horticultural product can qualify the gross receipts for the Specified Cooperative partner, and (2) a partnership can be attributed the activities of the Specified Cooperative partner (including those activities that a specified partner is attributed from patrons) so that the gross receipts can be DPGR.

III. § 1.199A-9, Domestic Production Gross Receipts

A. In General

Section 199A(g)(3)(D) defines the term

DPGR

to mean gross receipts of a Specified Cooperative derived from any lease, rental, license, sale, exchange, or other disposition (collectively, a disposition) of any agricultural or horticultural product which was MPGE (determined after application of section 199A(g)(4)(B)) by the Specified Cooperative in whole or significant part within the United States. DPGR does not include gross receipts of the Specified Cooperative derived from a disposition of land or from services. Section 199A(g)(4)(B) treats marketing Specified Cooperatives as having MPGE any agricultural or horticultural product in whole or significant part within the United States if their patrons have done so. Proposed § 1.199A-9 provides rules for determining whether gross receipts are DPGR, and provides methods of allocating gross receipts between DPGR and non-DPGR. Proposed § 1.199A-9 was based on § 1.199-3 of the former section 199 regulations, but also incorporated rules from former § 1.199-1(d)(1) through (3) and § 1.199-1(e). Former § 1.199-1(d)(1) through (3) and § 1.199-1(e) relate to the allocation of gross receipts between DPGR and non-DPGR, determining whether an allocation method is reasonable, treating de minimis gross receipts as DPGR or non-DPGR, and the use of historical data to allocate gross receipts for certain multiple-year transactions. The Proposed Regulations were intended to be interpreted in a manner consistent with the interpretation under former section 199. Other than as described in response to the specific comments, the final regulations generally follow the Proposed Regulations.

B. Reasonable Method of Allocating Gross Receipts Between DPGR and Non-DPGR

Under proposed § 1.199A-9(c)(1), Specified Cooperatives must use a reasonable method when allocating gross receipts between DPGR and non-DPGR. This reasonable method must be consistently applied from one taxable year to another, and must clearly reflect the portion of gross receipts for the taxable year that is DPGR and the portion of gross receipts that is non-DPGR. Proposed § 1.199A-9(c)(2) provides that if a Specified Cooperative has the information readily available and can, without undue burden or expense, specifically identify whether the gross receipts are derived from an item as defined in proposed § 1.199A-9(e)(1)(i) (and thus, are DPGR), then the Specified Cooperative must use that specific identification method to determine DPGR. If the Specified Cooperative does not have information readily available to specifically identify whether gross receipts are derived from an item or cannot, without undue burden or expense, specifically identify whether the gross receipts are derived from an item, then the Specified Cooperative can use a reasonable method. Among the seven factors listed for determining whether a method is reasonable is whether the Specified Cooperative applies the method consistently from year to year.

A commenter observed that former § 1.199-8(a) did not prevent taxpayers from choosing a reasonable method on a year-to-year basis, and that former § 1.199-8(a) provided that a taxpayer's change in allocating or apportioning items did not constitute a change in method of accounting to which the provisions of sections 446 and 481 and the regulations under sections 446 and 481 apply. The Treasury Department and the IRS agree with the commenter that any change to an allocation or apportionment of items should not constitute a change in method of accounting to which the provisions of sections 446 and 481 and the regulations under sections 446 and 481 apply. However, the final regulations maintain the rule from the Proposed Regulations. The Treasury Department and the IRS incorporated the “consistently applied” requirement into proposed § 1.199A-9(c)(1) to be consistent with the section 199A(a) regulations, specifically § 1.199A-3(b)(5). Further, if a method is not reasonable because it no longer clearly reflects the gross receipts from DPGR and non-DPGR, the method cannot continue to be used. The Specified Cooperative must choose a new method that is reasonable under the facts and circumstances and apply it consistently going forward.

The same commenter also claimed that former section 199 did not subject the “any reasonable method” determination to the § 1.199A-9(c)(2) factors. This is incorrect, as the proposed § 1.199A-9(c)(2) factors follow former § 1.199-1(d)(2), including the factor of whether the taxpayer applies

the method consistently from year to year. Therefore, the use of consistency as a factor (§ 1.199A-9(c)(2)) follows former § 1.199-1(d)(2).

C. Interaction of MPGE Rules in Proposed § 1.199A-9(f)(1) With (f)(2) and (3)

MPGE

is defined under proposed § 1.199A-9(f)(1) as manufacturing, producing, growing, extracting, installing, developing, improving, and creating agricultural or horticultural products; making agricultural or horticultural products out of material by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles; and cultivating soil, raising livestock, and farming aquatic products. MPGE also includes storage, handling, or other processing activities (other than transportation activities) within the United States related to the sale, exchange, or other disposition of agricultural or horticultural products only if the products are consumed in connection with or incorporated into the MPGE of agricultural or horticultural products, whether or not by the Specified Cooperative. The Specified Cooperative (or the patron if § 1.199A-9(a)(2) applies) must have the benefits and burdens of ownership of the agricultural or horticultural products under Federal income tax principles during the period the MPGE activity occurs in order for the gross receipts derived from the MPGE of the agricultural or horticultural products to qualify as DPGR. Under proposed § 1.199A-9(f)(2) and (3), if a Specified Cooperative engages in packaging, repackaging, labeling, or installation of an agricultural or horticultural product, and engages in no other MPGE activity with respect to the agricultural or horticultural product, then the activities of packaging, repackaging, labeling, or installation do not qualify as MPGE with respect to the agricultural or horticultural product.

A commenter suggested the removal of § 1.199A-9(f)(2) and (3) on the grounds that “packaging, repackaging, or labelling, [and] installing” cannot be distinguished from “storage, handling, and other processing activities” mentioned in proposed § 1.199A-9(f)(1).

The Joint Committee Report, in footnote 118, citing § 1.199-3(e)(1), provides that gross receipts of a Specified Cooperative may qualify as DPGR so long as the Specified Cooperative performs storage, handling, or other processing activities (other than transportation activities) within the United States, provided the products are consumed in connection with, or incorporated into, the MPGE of agricultural or horticultural products (whether or not by the Specified Cooperative). Thus, the Proposed Regulations' definition of MPGE included that language. However, § 1.199A-9(f)(2) and (3) effectively serve as minimum thresholds for purposes of MPGE qualification under § 1.199A-9(f)(1). These requirements were also part of the former section 199 regulations at the time of repeal (see former § 1.199-3(e)(2) and (3)). A logical reading of these paragraphs is that the storage, handling, and other processing activities that are described in § 1.199A-9(f)(1) are activities that are more extensive than those described in § 1.199A-9(f)(2) and (3). Thus, the final regulations do not adopt this suggestion.

Commenters requested the inclusion of Examples 1 and 2 of former § 1.199-3(e)(5) to affirm that the storage of farm products qualifies as MPGE. These examples deal with relevant fact patterns, but required modification to apply to Specified Cooperatives as the examples in former § 1.199-3(e)(5) explicitly state that all taxpayers are not Cooperatives. Therefore, Examples 1 and 2, with appropriate modifications, have been added under § 1.199A-9(f)(5).

IV. § 1.199A-10, Costs Allocable to DPGR

Section 1.199A-10 provides guidance on the allocation of costs to DPGR. This section provides rules for allocating a taxpayer's COGS, as well as other expenses, losses, and deductions properly allocable to DPGR. The Proposed Regulations were based on and follow the former section 199 regulations in § 1.199-4. No comments were received on this part of the Proposed Regulations, and so § 1.199A-10 of the Proposed Regulations is adopted without change by the final regulations.

V. § 1.199A-11, Wage Limitation

Section 1.199A-11 provides guidance regarding the W-2 wage limitation on the section 199A(g) deduction. No comments were received on this part of the Proposed Regulations, and so § 1.199A-11 of the Proposed Regulations is adopted without change by the final regulations.

A notice of proposed revenue procedure, Notice 2019-27, 2019-31 IRB, which proposed a draft revenue procedure providing three proposed methods that Specified Cooperatives may use for calculating W-2 wages, was issued concurrently with the Proposed Regulations. A revenue procedure is a statement of procedure that affects the rights or duties of taxpayers under the Code. Consistent with the general purpose of publishing revenue procedures in the Internal Revenue Bulletin, the methods that taxpayers may use for calculating W-2 wages are set forth in a revenue procedure to promote a uniform application of the laws administered by the IRS. The revenue procedure may be modified independently from the regulations under section 199A if, for example, changes unrelated to section 199A or the regulations thereunder are made to the underlying Form W-2, Wage and Tax Statement. No comments were received on Notice 2019-27. A revenue procedure that conforms with the draft, with one modification related to short taxable years, is being issued concurrently with the final regulations.

VI. § 1.199A-12, Expanded Affiliated Group (EAG) Rules

Proposed § 1.199A-12 provides guidance on the application of section 199A(g) to an expanded affiliated group (EAG) that includes a Specified Cooperative. Section 199A(g)(5)(A)(iii) defines an EAG as an “affiliated group as defined in section 1504(a),” except that the ownership threshold is “more than 50 percent” as opposed to “at least 80 percent.” Section 1504(a)(1) defines an affiliated group as “1 or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation . . . .” Section 1504(b)(1) further provides that the term “includible corporation” excludes “[c]orporations exempt from taxation under section 501.” Thus, the final regulations clarify that exempt Specified Cooperatives are not eligible to be members of an EAG. See § 1.1381-2(a)(1) (treating farmers' cooperatives that are exempt from tax under section 521 (such as Specified Cooperatives) as exempt organizations under section 501 “[f]or the purpose of any law that refers to organizations exempt from income taxes”). As a result, for purposes of section 199A(g), an EAG may include nonexempt Specified Cooperatives as well as other includible corporations.

The Proposed Regulations provide that the section 199A(g) deduction for an EAG is determined by separating patronage and nonpatronage gross receipts and related deductions of Specified Cooperatives that are members of the EAG. The section 199A(g) deduction is then computed solely with respect to patronage gross receipts and related deductions (patronage items). As explained in part VII of this Summary of Comments and Explanation of Revisions, patronage items are items of income or deduction

produced by a transaction that actually facilitates the accomplishment of the Specified Cooperative's marketing, purchasing, or services activities. See

Farmland Industries, Inc.

v.

Comm'r,

78 T.C.M. 846 (CCH) (1999); § 1.1388-1(f).

Thus, the Proposed Regulations effectively have two specific rules addressing the computation of the section 199A(g) deduction for an EAG that includes a Specified Cooperative. First, the section 199A(g) deduction is computed using only patronage items (the EAG patronage limitation). Second, only members of an EAG that are Specified Cooperatives are taken into account in computing the section 199A(g) deduction (the Specified Cooperative limitation).

A commenter recommended that the final regulations eliminate the EAG patronage limitation. Specifically, as discussed in part II of this Summary of Comments and Explanation of Revisions, the commenter argued that the general requirement to distinguish income, deductions, and W-2 wages from patronage and nonpatronage activities conflicts with the policy of section 199A, and that such a requirement is equally inappropriate for EAGs that include Specified Cooperatives.

The Treasury Department and the IRS do not agree with the commenter's argument. Under subchapter T, patronage income of a nonexempt cooperative with both patronage and nonpatronage activities effectively receives single-level tax treatment, whereas nonpatronage income of such a cooperative is taxed at both the corporate level and the shareholder level.

Farm Service Coop.

v.

Comm'r,

619 F.2d 718, 723 (8th Cir. 1980). Because the commenter's proposal would extend the benefits of the section 199A(g) deduction to nonpatronage activities, with respect to which a nonexempt cooperative is taxed as a C corporation, it is inconsistent with the purposes and structure of section 199A. Moreover, eliminating the patronage limitation solely in the context of an EAG would disadvantage nonexempt Specified Cooperatives that are not members of an EAG because such entities, unlike their counterparts in an EAG, would be prohibited from taking a section 199A(g) deduction on nonpatronage sourced gross receipts.

Thus, the final regulations do not adopt the commenter's recommendation to compute the section 199A(g) deduction using both patronage and nonpatronage items in either the standalone context (see part II of this Summary of Comments and Explanation of Revisions) or for EAGs. Instead, activities resulting in nonpatronage income continue to be taxed as income from a noncooperative C corporation.

The same commenter also recommended eliminating the Specified Cooperative limitation, specifically arguing that, because C corporations that are not Specified Cooperatives can be members of an EAG, such corporations also should be taken into account in computing the section 199A(g) deduction for an EAG. The commenter also stressed that the approach in proposed § 1.199A-12 is different from the approach in the former section 199 EAG rules, which provide the basis for the rules in proposed § 1.199A-12.

The final regulations also do not adopt this recommendation. Unlike the former section 199 deduction, which was broader in scope, section 199A(g) specifically provides that only a “taxpayer which is a specified agricultural or horticultural cooperative” (that is, a Specified Cooperative) may claim the section 199A(g) deduction. Moreover, as noted in part II of this Summary of Comments and Explanation of Revisions, C corporations are expressly prohibited under section 199A(a) from claiming a section 199A(a) deduction, and C corporations other than Specified Cooperatives under section 199A(g)(2)(D)(i) from claiming a section 199A(g) deduction as a patron of a Specified Cooperative. Although the statute does not expressly prohibit C corporations that are not Specified Cooperatives from being taken into account in computing an EAG's section 199A(g) deduction, the fact that the statute expressly limits this deduction to Specified Cooperatives, and the statute's general prohibition against C corporations that are not Specified Cooperatives benefiting from the section 199A(g) deduction, indicate that the Specified Cooperative limitation is consistent with the structure and intent of section 199A.

Additionally, eliminating the Specified Cooperative limitation would have no practical effect unless the EAG patronage limitation also were eliminated. Nonexempt Specified Cooperatives receive single-level tax treatment only to the extent of patronage income generated and distributed to their patrons; their nonpatronage income continues to be taxed at both the corporate level and the shareholder level. Accordingly, the net effect of the Specified Cooperative limitation is to exclude what otherwise would be nonpatronage income, because a C corporation that is not a Specified Cooperative cannot generate patronage income. Because the final regulations retain the EAG patronage limitation, removing the Specified Cooperative limitation would have no practical effect with respect to nonexempt Specified Cooperatives. As previously noted, removing the Specified Cooperative limitation would not affect the treatment of exempt Specified Cooperatives because they are not eligible to be members of an EAG. See section 1504(b)(1); § 1.1381-2(a)(1).

Finally, revisions necessary to clarify the scope and application of section 199A(g) to an EAG that includes a Specified Cooperative were made in § 1.199A-12 of the final regulations.

VII. § 1.1382-3, Taxable Income of Cooperatives; Special Deductions for Exempt Farmers' Cooperatives; and § 1.1388-1, Definitions and Special Rules

A. Comments on Definition of “Patronage and Nonpatronage”

Section 1.1388-1 provides definitions and special rules applicable to Cooperatives. The Proposed Regulations added a definition of

patronage and nonpatronage

in proposed § 1.1388-1(f). Proposed § 1.1388-1(f) provides “[w]hether an item of income or deduction is patronage or nonpatronage sourced is determined by applying the directly related use test. The directly related use test provides that if the income or deduction is produced by a transaction that actually facilitates the accomplishment of the cooperative's marketing, purchasing, or services activities, the income or deduction is from patronage sources. However, if the transaction producing the income or deduction does not actually facilitate the accomplishment of these activities but merely enhances the overall profitability of the cooperative, being merely incidental to the association's cooperative operation, the income or deduction is from nonpatronage sources. Patronage and nonpatronage income or deductions cannot be netted unless otherwise permitted by the Internal Revenue Code or regulations issued under the relevant section of the Internal Revenue Code, or guidance published in the Internal Revenue Bulletin (

see

§ 601.601(d)(2) of this chapter).”

Commenters questioned the need for adopting a definition in connection with guidance under section 199A(g), as the definition will impact all Cooperatives. However, a common determination for all Cooperatives is identifying activities as patronage or nonpatronage. Prior to the Proposed Regulations, there was no single definition of patronage and

nonpatronage. The definition of

income derived from sources other than patronage

in § 1.1382-3(c)(2), which was often cited as part of the determination, is outdated. As it relates to section 199A(g), the requirement to identify patronage and nonpatronage to calculate the section 199A(g) deduction places additional importance on the determination. To assist taxpayers in distinguishing between patronage and nonpatronage, proposed § 1.1388-1(f) was added. The intent in adding § 1.1388-1(f) was to incorporate the “directly related” test, which is the current legal standard for making the determination.

Commenters requested citations relevant to the proposed definition to ensure the language complies with the current legal standard. Other than the last sentence, the language adopted in the Proposed Regulations closely follows the language used in Rev. Rul. 69-576, 1969-2 C.B. 166, which provides “[t]he classification of an item of income as from either patronage or nonpatronage sources is dependent on the relationship of the activity generating the income to the marketing, purchasing, or service activities of the cooperative. If the income is produced by a transaction which actually facilitates the accomplishment of the cooperative's marketing, purchasing, or service activities, the income is from patronage sources. However, if the transaction producing the income does not actually facilitate the accomplishment of these activities but merely enhances the overall profitability of the cooperative, being merely incidental to the association's cooperative operation, the income is from nonpatronage sources.”

The language from Rev. Rul. 69-576 has been cited in numerous opinions, including

Farmland Industries, Inc.

v.

Comm'r,

78 T.C.M. 846 (CCH) (1999), which provides a summary of published guidance and many of the cases relevant to the current legal standard. In the

Farmland

opinion, the court states that “the `directly related test' applied by the courts is traceable to published rulings issued by the Commissioner, such as Rev. Rul. 69-576, 1969-2 C.B. 166, and Rev. Rul. 74-160, 1974-1 C.B. 245, that interpreted patronage income broadly.”

Farmland

at 865.

Commenters also suggested removal of § 1.1388-1(f) on the basis that patronage/nonpatronage determinations necessitate a facts and circumstances analysis, and, therefore § 1.1388-1(f) is inappropriate. Section 1.1388-1(f) provides a definition, it does not eliminate the necessity for factual analysis. Therefore, the final regulations do not adopt this comment.

Alternatively, one commenter requested that the definition in § 1.1388-1(f) be modified to provide that income is from patronage sources if the underlying transaction is either directly related or actually facilitates the cooperative's purpose. The final regulations do not adopt this comment. The definitional language of § 1.1388-1(f) follows the language from Rev. Rul. 69-576 and is also consistent with language in

Farmland.

However, revisions have been made to clarify the distinction between patronage and nonpatronage sourced items.

The commenter also suggested the removal of the last sentence of the definition, which prohibited the netting of patronage and nonpatronage items. The Treasury Department and the IRS agree that the “netting” rule is not needed to define patronage and nonpatronage. Therefore, the last sentence of proposed § 1.1388-1(f) is removed from the definition in the final regulations.

B. Comments on Removing the Definition of “Income From Sources Other Than Patronage”

The commenter also requested that if a definition was finalized, then the definition of

income from sources other than patronage

in § 1.1382-3(c)(2) be removed. The Treasury Department and the IRS agree that this section should be revised. The final regulations revise this section so that it now cross-references the definition of

patronage and nonpatronage

in § 1.1388-1(f).

VIII. Removal of Section 199 Regulations

In light of the TCJA, the Treasury Department and the IRS proposed to remove the former section 199 regulations (§§ 1.199-0 through 1.199-9) and withdrew the 2015 proposed regulations because the regulations interpret a provision of the Code that has been repealed for taxable years beginning after December 31, 2017. No comments were received, and the final regulations remove the former section 199 final regulations (§§ 1.199-0 through 1.199-9, including expired temporary regulations published in the

Federal Register

as TD 9731).

The removal of these regulations is unrelated to the substance of the rules in the regulations, and no negative inference regarding the stated rules should be made. The regulations are removed from the Code of Federal Regulations (CFR) solely because they have no future applicability. Removal of these regulations is not intended to alter any non-regulatory guidance that cites to or relies upon these regulations. These regulations as contained in 26 CFR part 1, revised April 1, 2019, remain applicable to determining eligibility for the former section 199 deduction for any taxable year that began before January 1, 2018. The beginning date of the taxable year of a partnership, S corporation, or a non-grantor trust or estate, rather than the taxable year of a partner, shareholder, or beneficiary is used to determine items that are taken into account for purposes of calculating a former section 199 deduction.

IX. Comments on Proposed Applicability Date and Transition Rule

A commenter requested that the final regulations be made applicable to taxable years beginning after the publication date. The final regulations adopt the commenter's request.

Regarding the transition rule, proposed § 1.199A-7(h)(2) provides that no deductions under section 199A are allowed to patrons for any qualified payments that are attributable to QPAI with respect to which a deduction is allowable to the Specified Cooperative under former section 199 as in effect on and before December 31, 2017, for a taxable year of the Cooperative beginning before January 1, 2018. Additionally proposed § 1.199A-7(h)(3) provides that if a patron of a Cooperative cannot claim a deduction under section 199A(a) for any qualified payments described in the transition rule of § 1.199A-7(h)(2), the Cooperative must report this information on an attachment to or on the Form 1099-PATR (or any successor form) issued by the Cooperative to the patron, unless otherwise provided by the instructions to the form.

The commenter also requested omission of references to the transition rule and confirmation that any reasonable application of the transition rule will be deemed appropriate. This request was based on the presumption that these regulations would not be finalized until after 2019, when the time period covered by the transition rule has passed, thus requiring the amendment of Forms 1099-PATR (and corresponding Forms 1040, U.S. Individual Income Tax Return). The commenter also suggested that Cooperatives have a common understanding of the transition rule to the extent that payments described under proposed § 1.199A-7(h)(2) would be properly identified and not included in patrons' section 199A(a) calculations. The commenter, however, did not identify a specific method that

Cooperatives primarily used. The final regulations amend the rule from proposed § 1.199A-7(h)(2) so that it now only cross-references section 101(c) of Division T of the 2018 Act. The final regulations also amend proposed § 1.199A-7(h)(3) to allow Cooperatives to use a reasonable method to identify the payments, and state that the method from the Proposed Regulations of reporting on an attachment to or on Form 1099-PATR (or successor form) is one reasonable method.

Applicability Dates

Section 7805(b)(1)(A) and (B) of the Code generally provide that no temporary, proposed, or final regulation relating to the internal revenue laws may apply to any taxable period ending before the earliest of (A) the date on which the regulation is filed with the

Federal Register

, or (B) in the case of a final regulation, the date on which a proposed or temporary regulation to which the final regulation relates was filed with the

Federal Register

.

Consistent with authority provided by section 7805(b)(1)(A), §§ 1.199A-7 through 1.199A-12, § 1.1382-3(c)(2) as revised, and § 1.1388-1(f) generally apply to taxable years beginning after January 19, 2021. However, taxpayers may choose to apply the rules set forth in §§ 1.199A-7 through 1.199A-12, § 1.1382-3(c)(2) as revised, and § 1.1388-1(f) for taxable years beginning on or before January 19, 2021, provided, in each case, the taxpayers follow the rules in their entirety and in a consistent manner. Alternatively, taxpayers may rely on the proposed regulations under §§ 1.199A-7 through 1.199A-12 issued on June 19, 2019 for taxable years beginning on or before January 19, 2021 and taxpayers may rely on the proposed regulations under § 1.1388-1(f) issued on June 19, 2019 for taxable years beginning on or before January 19, 2021, provided, in each case, taxpayers follow the proposed regulations in their entirety and in a consistent manner.

Special Analyses

I. Regulatory Planning and Review—Economic Analysis

Executive Orders 13771, 13563 and 12866 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility.

These regulations have been designated by the Office of Management and Budget's Office of Information and Regulatory Affairs (OIRA) as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations. OIRA has determined that the final rulemaking is significant and subject to review under Executive Order 12866 and section 1(b) of the Memorandum of Agreement. Accordingly, the final regulations have been reviewed by the Office of Management and Budget.

A. Background and Overview

The TCJA repealed section 199 of the Code, which provided a deduction for income attributable to domestic production activities. In its place it created section 199A, which provides a deduction for qualified business income derived from passthrough businesses—such as sole proprietorships, partnerships, and S corporations—engaged in domestic trades or businesses. While the repealed section 199 deduction was generally available to all taxpayers, the section 199A(a) deduction is available only to taxpayers other than C corporations, including patrons of cooperatives to which sections 1381 through 1388 of the Code apply (Cooperatives). On March 23, 2018, section 101 of the 2018 Act amended section 199A(g) to provide deductions for Specified Cooperatives and their patrons that are substantially similar to the deductions allowed under the repealed section 199 deduction. Accordingly, these regulations generally formalize prior and current practices based on the rules under former section 199. The 2018 Act also added section 199A(b)(7), which requires patrons of Specified Cooperatives to reduce their section 199A(a) deduction if those patrons receive qualified payments from Specified Cooperatives.

The estimated number of Cooperatives affected by the 2018 Act and these final regulations is 9,200, including approximately 2,000 Specified Cooperatives, based on 2018 tax filings.

B. Need for Regulation

The final regulations provide guidance regarding the application of sections 199A(a), 199A(b)(7), and 199A(g) to Cooperatives, Specified Cooperatives, and their patrons. The final regulations are needed because the 2018 Act introduced a number of terms and calculations. Patrons, Cooperatives, and Specified Cooperatives would benefit from greater specificity regarding these and other items.

C. Economic Analysis

1. Baseline

The Treasury Department and the IRS have assessed the benefits and costs of the final regulations relative to a no-action baseline reflecting anticipated Federal income tax-related behavior in the absence of these regulations.

2. Economic Rationale for Issuing Guidance for the 2018 Act

The Treasury Department and the IRS anticipate that the issuance of guidance pertaining to sections 199A(a), 199A(b)(7), and 199A(g) of the 2018 Act to Cooperatives, Specified Cooperatives, and their patrons will provide a marginal net economic benefit to the overall U.S. economy.

The final regulations clarify a number of concepts for Cooperatives and their patrons, regarding the deduction provided by section 199A(a) for qualified business income, as well as for Specified Cooperatives and their patrons regarding the section 199A(g) deduction on income attributable to the domestic production activities of Specified Cooperatives. Specifically, the final regulations (i) clarify how Specified Cooperatives should determine their section 199A(g) deduction; (ii) define “agricultural or horticultural products” to clarify which Cooperatives qualify as Specified Cooperatives eligible for the section 199A(g) deduction; (iii) provide de minimis rules reducing compliance costs for certain Specified Cooperatives; (iv) require reporting from Cooperatives; (v) provide a safe harbor permitting certain patrons of Specified Cooperatives to use a simpler method to calculate the section 199A(b)(7) reduction to the section 199A(a) deduction; (vi) permit patrons to allocate their expenses to calculate the correct amount of qualified business income and their section 199A(a) deduction; (vii) permit, but do not require, Specified Cooperatives to identify the eligibility status of patrons to pass through the section 199A(g) deduction to them; and (viii) permit partnerships to pass through W-2 wages and cost of goods sold (COGS) to Specified Cooperative partners and permit attribution of a partnership's activities to a Specified Cooperative partner and a Specified Cooperative's partner's activities to a partnership. In the absence of guidance, affected

taxpayers would have to calculate their tax liability without the definitions and clarifications provided by the final regulations, a situation that is generally considered more burdensome and could lead to greater conflicts with tax administrators. Thus, the Treasury Department and the IRS project that the final regulations will marginally reduce taxpayer compliance burden and the costs of tax administration relative to not issuing any such guidance.

This guidance also ensures that section 199A deductions are calculated similarly across taxpayers, avoiding situations where one taxpayer receives preferential treatment over another for fundamentally similar economic activity. For example, in the absence of these final regulations, a Specified Cooperative may have uncertainty over what type of income is eligible for the section 199A(g) deduction. If a Specified Cooperative claimed the section 199A(g) deduction on income that is taxed similarly to a C corporation, this would confer an unintended economic benefit to the Specified Cooperative over other C corporations performing identical activities that only benefit from a lower corporate tax rate. As discussed further below, this guidance prevents the introduction of distortions of economic decisions in the agricultural or horticultural sector.

In the absence of these regulations, uncertainty over statutory interpretation could lead to economic losses to the extent that taxpayers interpret the statute in ways that are inconsistent with the statute's intents and purposes. For example, a Specified Cooperative may pursue a project involving a certain product that is only profitable if that product is deemed “agricultural or horticultural” and thus eligible for the section 199A(g) deduction. If, in fact, this product is ineligible for the deduction based on the intents and purposes of the statute, then the project should not have been pursued and this results in an economic loss. Alternatively, without a definition of “agricultural or horticultural,” a Specified Cooperative may incorrectly assume that a project is not eligible for the deduction and not pursue the project, which could also result in an economic loss. In such cases, guidance provides value by supporting decision-making that is economically efficient, contingent on the overall Code. While no guidance can fully curtail all inaccurate interpretations of the statute, the final regulations significantly mitigate the chance for such interpretations and thereby increase economic efficiency. Due to the lack of readily available data, the Treasury Department and the IRS have not estimated the increase in United States economic activity that would arise from the guidance.

The Treasury Department further projects that the issuance of guidance will reduce taxpayer compliance burden and the costs of tax administration relative to a no-action baseline. Due to the lack of readily available data, the Treasury Department has not estimated the decrease in taxpayer compliance burden nor tax administration costs arising from the issuance of guidance.

No comments were received on the economic analysis provided in the proposed regulations.

3. Economic Analysis of Specific Provisions

The final regulations embody certain regulatory decisions that reflect necessary regulatory discretion. These decisions specify more fully how the 2018 Act is to be implemented.

i. Determining Section 199A(g) Deduction for Specified Cooperatives

The final regulations outline the process by which Specified Cooperatives calculate their section 199A(g) deductions. The rules concern two types of Specified Cooperatives, those that are exempt (qualified as a Cooperative under section 521) and those that are nonexempt (qualified under subchapter T of the Code), and two sources of income, patronage and nonpatronage. The patronage and nonpatronage income of Specified Cooperatives is taxed differently depending on whether the Specified Cooperative is exempt or nonexempt. In the case of exempt Specified Cooperatives, patronage and nonpatronage source income is subject to a single level of tax at the patron level. Whereas, for nonexempt Specified Cooperatives only patronage source income is subject to a single level of tax at the patron level; nonpatronage source income is subject to a double level of tax, similar to other C corporation income.

Because the Code does not define

patronage and nonpatronage sourced items,

§ 1.1388-1(f) of these final regulations sets forth a definition that is consistent with the current state of federal case law. Specifically, the definition adopts the directly related test, which is a fact specific test for determining whether income and deductions of a Cooperative are patronage or nonpatronage. The final regulations also make revisions to clarify patronage versus nonpatronage items. In response to a commenter, the final regulations remove the last sentence in the proposed definition, because the Treasury Department and the IRS agree that the sentence is not needed to define patronage and nonpatronage. Specifying a definition that is consistent with current case law will help to minimize the economic impacts of these regulations that may arise from lack of clarity.

The final regulations adopt the proposed rule requiring Specified Cooperatives to identify gross receipts, COGS, deductions, W-2 wages, etc. as patronage or nonpatronage, and only allows the patronage activities of nonexempt Specified Cooperatives to be included in the calculation of the section 199A(g) deduction, unless the Specified Cooperative falls under the expanded de minimis rules, which are discussed later. The TCJA reduced the corporate tax rate for C corporations under section 11 and provided the section 199A deduction for domestic businesses operating as sole proprietorships or through partnerships, S corporations, trusts, or estates. The TCJA also repealed section 199, which did not preclude deductions on income earned by C corporations. The 2018 Act amended section 199A to address concerns that the TCJA created an unintended incentive for farmers to sell their agricultural or horticultural products to Specified Cooperatives over independent buyers. Specifically, the 2018 Act amended section 199A(g) to allow Specified Cooperatives and their patrons a deduction similar to the former section 199 deduction. Because the section 199A(g) deduction is not intended to benefit C corporations and their shareholders, in general, the final regulations specify that the section 199A(g) deduction can be claimed only on income that can be subject to tax only at the patron level. Under the final regulations, a non-exempt Specified Cooperative may not claim the section 199A(g) deductions on income that cannot be paid to patrons and deducted under section 1382(b) and exempt Specified Cooperatives may not claim section 199A(g) deductions on income that cannot be paid to patrons and deducted under sections 1382(b) or 1382(c)(2).

In the absence of these regulations, a Specified Cooperative may have uncertainty as to whether nonpatronage source income, which would be taxed in the same manner as a C corporation, could receive both the lower corporate tax rate and be further offset by a section 199A(g) deduction. Other C corporations performing identical activities would only benefit from the lower corporate tax rate. This would

confer an unintended economic benefit to Specified Cooperatives over other C corporations and undermine the intent of the 2018 Act's amendments of section 199A to reduce competitive distortions between C corporations and Specified Cooperatives.

The Treasury Department and the IRS have determined that this potential uncertainty as to tax treatment could distort economic decisions in the agricultural or horticultural sector. The final regulations avoid this outcome, promoting a more efficient allocation of resources by providing more uniform incentives across taxpayers.

ii. Definition of Agricultural or Horticultural Products

The section 199A(g) deduction is focused solely on dispositions of agricultural or horticultural products. As a result, the Treasury Department and the IRS determined that it was necessary to provide a definition. Because there is no definition of

agricultural or horticultural products

in the Code or Income Tax Regulations, the Treasury Department and the IRS looked to the United States Department of Agriculture (USDA) for definitions because the USDA has expertise concerning Specified Cooperatives, and Specified Cooperatives are likely familiar with USDA law. The proposed regulations defined

agricultural or horticultural products

within the meaning of the Cooperative Marketing Act of 1926 as agricultural, horticultural, viticultural, and dairy products, livestock and the products thereof, the products of poultry and bee raising, the edible products of forestry, and any and all products raised or produced on farms and processed or manufactured products thereof. Agricultural or horticultural products also include aquatic products that are farmed as well as fertilizer, diesel fuel, and other supplies used in agricultural or horticultural production that are manufactured, produced, grown, or extracted by the Specified Cooperative. Agricultural or horticultural products, however, do not include intangible property, since agricultural or horticultural products were considered a subset of tangible property under former section 199. Intangible property (defined in § 1.199-3(j)(2)(iii)) was a separate category of property and gross receipts from intangible property did not qualify as domestic production gross receipts (DPGR).

The final regulations made clarifying changes to the definition of agricultural or horticultural products in response to commenters. The final regulations provide examples (without limitation) of products that are considered agricultural or horticultural products, including specific agricultural or horticultural products, livestock products, edible forestry products, and farmed aquatic products. The final regulations also provide language further clarifying that agricultural or horticultural products do not include intangible property. Finally, the final regulations include more examples of “other supplies” being agricultural or horticultural products.

The Treasury Department and the IRS considered a similar but alternative definition of

agricultural or horticultural

products within the meaning of the Agricultural Marketing Act of 1946 as agricultural, horticultural, viticultural, and dairy products, livestock and poultry, bees, forest products, fish and shellfish, and any products thereof, including processed and manufactured products, and any and all products raised or produced on farms and any processed or manufactured product thereof. While very similar to the definition in the rules adopted in these final regulations, the rules under the Agricultural Marketing Act of 1946 concern the marketing and distribution of agricultural products without reference to Cooperatives.

The Treasury Department and the IRS also considered an alternative definition of

agricultural or horticultural products

based on the definition of agricultural commodities within the meaning of general regulations under the Commodity Exchange Act. The Treasury Department and the IRS concluded that this definition was too narrow, because it is limited to products that can be commodities. The use of this narrow definition would have restricted the range of products for which the section 199A(g) deduction would be otherwise available.

The Treasury Department and the IRS did not attempt to provide quantitative estimates of the economic consequences of different designations of agricultural or horticultural products because suitable data are not readily available at this level of detail.

iii. De Minimis Threshold for Domestic Production Gross Receipts of Specified Cooperatives

In general, § 1.199A-9 of the final regulations requires that Specified Cooperatives allocate gross receipts between DPGR and non-DPGR. However, § 1.199A-9(c)(3) of the proposed regulations includes a de minimis provision that allows Specified Cooperatives to allocate total gross receipts to DPGR if less than 5 percent of total gross receipts are non-DPGR or to allocate total gross receipts to non-DPGR if less than 5 percent of total gross receipts are DPGR. The thresholds provided in the proposed regulations are based on the thresholds set forth in § 1.199-1(d)(3) under former section 199. The Treasury Department and the IRS chose to include a de minimis rule to reduce compliance costs and simplify tax filing relative to an alternative of no de minimis rule.

The Treasury Department and the IRS considered changes to the de minimis provisions in the proposed regulations, but determined that materially changing these rules from provisions that were previously available would lead to taxpayer confusion. The final regulations generally maintain the rules of the proposed regulations, but increase the threshold. Thus, under § 1.199A-9(c)(3) of the final regulations, Specified Cooperatives when calculating the patronage section 199A(g) deduction may allocate total gross receipts to DPGR if less than 10 percent of total gross receipts are non-DPGR (which now can include nonpatronage gross receipts as well as patronage non-DPGR pursuant to § 1.199A-8(b)(2)(ii)), or alternatively, may allocate total gross receipts to non-DPGR if less than 10 percent of total gross receipts are DPGR. The de minimis threshold modestly reduces compliance costs for businesses with relatively small amounts of non-DPGR or DPGR by allowing them to avoid allocating receipts between DPGR and non-DPGR activities. The de minimis threshold is unlikely to create any substantial effects on market activity because any change in the ratio of DPGR to non-DPGR will be localized around the threshold, meaning that the movement will be a small fraction of receipts to get below the de minimis threshold. Because the de minimis provision exempts taxpayers from having to perform certain allocations and therefore reporting these allocations, the Treasury Department and the IRS do not have information on taxpayers' use of this exemption under former section 199 to perform a quantitative analysis of the impacts of the de minimis provision.

iv. Reporting Requirements for Cooperatives

Final regulations § 1.199A-7(c) and (d) provide that, when a patron conducts a trade or business that receives distributions from a Cooperative, the Cooperative is required to provide the patron with qualified items of income, gain, deduction, and loss and specified service trade or business (SSTB) determinations with

respect to those distributions. This increases the compliance burden on such Cooperatives. However, in the absence of these regulations, the burden for determining of the amount of distributions from a Cooperative that constitute qualified items of income, gain, deduction, and loss from a non-SSTB and an SSTB would lie with the patron. Because patrons are less well positioned to acquire the relevant information to determine whether distributions from a Cooperative are qualified items of income, gain, deduction, and loss and whether items that would otherwise qualify are from an SSTB, the Treasury Department and the IRS expect that these regulations will reduce overall compliance costs relative to an alternative approach of not introducing a reporting requirement. After consideration of comments, the reporting requirements of Cooperatives have been modified to simplify the Cooperatives' reporting obligations in order to balance the burden on the Cooperatives and the patrons' need to receive information to determine their section 199A(a) deduction.

v. Allocation Safe Harbor

If a patron receives both income or gain related to qualified payments and income or gain that is not related to qualified payments in a qualified trade or business, the patron must allocate those items and related deductions, losses, and W-2 wages using a reasonable method based on all of the facts and circumstances. The final regulations provide a safe harbor that allows patrons who receive income or gain related to qualified payments in addition to income or gain that is not related to qualified payments to use a simpler method to allocate deductions, losses, and W-2 wages between income or gain related to qualified payments and income or gain that is not related to qualified payments to calculate the section 199A(b)(7) reduction to the section 199A(a) deduction. The safe harbor allocation method allows patrons to allocate by ratably apportioning deductions, losses, and W-2 wages based on the proportion that the amount of income or gain related to qualified payments bears to the total income or gain used to determine QBI. This safe harbor is available to patrons with taxable incomes below the threshold amounts set forth in section 199A(e)(2).

The Treasury Department and the IRS considered an alternative of not allowing a safe harbor but determined that a safe harbor could reduce compliance costs and simplify tax filing. The threshold was set at amounts set forth in section 199A(e)(2) to avoid a proliferation of thresholds applicable to taxpayers claiming a section 199A(a) deduction. Because the threshold amounts are relatively low, the Treasury Department and the IRS expect that the safe harbor would not distort business decisions or reduce revenue to any meaningful extent.

i. Patrons May Allocate Expenses to Specified Service Trade or Business Items of Income Reported by Cooperative

A commenter asked the Treasury Department and the IRS to revise proposed reporting requirements in circumstances where a Cooperative engages in a specified service trade or business (SSTB) business with patrons. In response to the commenter's request, the final regulations allow patrons to allocate expenses between qualified trade or business income and any SSTB income received from the Cooperative up to the amount of the income from the SSTB. The final regulations more accurately track the substance of the transaction. In the absence of these regulations, the patron may calculate lower qualified business income, resulting in a lower section 199A(a) deduction.

ii. Specified Cooperatives May Pass Through All, Some, or None of the Section 199A(g) Deduction

Section 199A(g) permits Specified Cooperatives to pass through their section 199A(g) deduction, and allows eligible taxpayers to claim the deduction passed through. The proposed regulations required Specified Cooperatives to identify whether the patrons are eligible taxpayers and only pass through the deduction to those patrons. Commenters requested that the rule be modified so that patrons, and not Specified Cooperatives, have to identify whether the patrons are eligible taxpayers for purposes of using the section 199A(g) deduction. The rules have been modified in the final regulations to provide Specified Cooperatives with maximum flexibility. If a Specified Cooperative does not identify the eligibility status of all of its patrons, it may pass through all, some, or none of the section 199A(g) deduction. Only patrons that are eligible taxpayers may use the section 199A(g) deduction passed through to them. If a Specified Cooperative does determine the eligibility status of its patrons, it has the discretion to retain the section 199A(g) deduction attributable to any ineligible taxpayer, and pass out the remainder to eligible taxpayers.

In the absence of these regulations, a Specified Cooperative may have uncertainty as to whether to distribute the section 199A(g) deduction to eligible taxpayers. The final regulations provide Specified Cooperatives with the option of retaining and using the amounts equal to the section 199A(g) deduction attributable to ineligible taxpayers, or passing out the deduction, which only eligible taxpayers may claim. This allows Specified Cooperatives to choose whether to engage in information gathering regarding patrons' eligibility to use the deduction. The Treasury Department and the IRS have determined that this increased flexibility promotes a more efficient allocation of resources by allowing Specified Cooperatives to choose the extent to which they engage in information gathering in relation to the use of the section 199A(g) deduction at the Specified Cooperative level or the patron level.

iii. Special Rule for Specified Cooperative Partners

The final regulations provide special rules for Specified Cooperatives that are partners in a partnership. A commenter recommended that the proposed regulations be modified to permit partnerships to pass through W-2 wages to Specified Cooperative partners, thereby increasing the Specified Cooperatives' section 199A(g) deduction. A commenter also recommended that, to the extent a partnership conducts activities that result in gross receipts, a Specified Cooperative partner in that partnership should be permitted to treat those activities as conducted directed by the Specified Cooperative. The Treasury Department and the IRS agree with these comments. The final regulations permit the partnerships to pass through W-2 wages and COGS to Specified Cooperative partners. Additionally, the final regulations allow for two-way attribution, meaning: (1) A partnership's activities alone with respect to an agricultural or horticultural product can qualify as gross receipts for the Specified Cooperative partner and (2) a partnership can be attributed the activities of the Specified Cooperative partner. These rules permit additional activities and the resulting income, as well as additional W-2 wages and COGS, to be considered in the calculation of the section 199A(g) deduction.

This stipulation allows for greater flexibility in determining deductions when Specified Cooperatives are partners. Flexibility will increase economic efficiency by making it more likely that Specified Cooperatives

comply with regulations by lowering the compliance burden.

The Treasury Department and the IRS anticipate that these regulations in aggregate will have a marginal impact on economic activity. Compared to the economic impacts resulting from the 2018 Act, the final regulations' primary impact will be through increasing comprehension of the tax code. Increased understanding will reduce the risk that firms and the IRS will disagree on tax reporting and allocation and therefore engage in costly legal transactions. Increased comprehension will also reduce the possibility that firms will engage in activities that would yield negative economic impacts if clarity were stronger. These final regulations also respond to commenters by adding additional examples to further increase comprehension.

II. Paperwork Reduction Act

The collection of information contained in these regulations has been revised and approved by the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) under control numbers 1545-0118 and 1545-0123.

Regulations in § 1.199A-7(c)(3), (d)(3), (f)(3), and (h)(3), as well as § 1.199A-8(d)(3) and (f), require the collection of information. The collections of information in § 1.199A-7(c)(3), (d)(3), (f)(3), and (h)(3), as well as § 1.199A-8(d)(3) will be conducted through Form 1099-PATR, Taxable Distributions Received From Cooperatives, while the collection of information in § 1.199A-8(f) will be conducted through Schedule K-1 to Form 1065, U.S. Return of Partnership Income.

A. Collections of Information Conducted Through Form 1099-PATR

Section 1.199A-7(c)(3) requires the Cooperative to inform its patron of the amount of any distribution to the patron that constitutes qualified items of income, gain, deduction, and loss from a non-specified service trade or business (SSTB) conducted directly by the Cooperative. Not all distributions to patrons are qualified items of income, gain, deduction, and loss because the source of the distribution may not be effectively connected with the conduct of a trade or business within the United States or may include interest income that is not properly allocable to the patron's trade or business. The Cooperative directly conducting the trade or business from which the distribution to the patron originates is in the best position to know how much of the distribution is qualified items of income, gain, deduction, and loss. The Cooperative is also in the best position to know if it is generating income from an SSTB. Accordingly, the collection of information is necessary for the patron to calculate correctly the patron's section 199A(a) deduction for the patron's trade or business.

Section 1.199A-7(d)(3) requires the Cooperative to inform its patron of the amount of any distributions to the patron that constitutes qualified items of income, gain, deduction, and loss from an SSTB conducted directly by the Cooperative. Accordingly, the collection of information is necessary for the patron to correctly calculate the patron's section 199A(a) deduction for the patron's qualified trade or business.

The collection of information in § 1.199A-7(f)(3) is essential for the eligible taxpayer's calculation of the reduction in the eligible taxpayer's section 199A(a) deduction for the eligible taxpayer's trade or business that is required by section 199A(b)(7). Section 199A(g)(2)(A) requires the Specified Cooperative to identify the amount of qualified payments being distributed to an eligible taxpayer and identify the portion of the section 199A(g) deduction allowed in a notice mailed to the eligible taxpayer during the payment period described in section 1382(d). Section 199A(b)(7) provides that an eligible taxpayer who receives qualified payments from a Specified Cooperative must reduce the eligible taxpayer's section 199A(a) deduction by an amount set forth in this section. Without the notice described in § 1.199A-7(f)(3), the eligible taxpayer cannot calculate the reduction required by section 199A(b)(7).

The collection of information in § 1.199A-8(d)(3) is necessitated by section 199A(g)(2)(A). Section 199A(g)(2)(A) permits a Specified Cooperative to pass through an amount of its section 199A(g) deduction to an eligible taxpayer. The amount of the section 199A(g) deduction that the Specified Cooperative is permitted to pass through is an amount that is allocable to the qualified production activities income (QPAI) generated from qualified payments distributed to the eligible taxpayer and identified by such cooperative in a written notice mailed to such taxpayer during the payment period described in section 1382(d). Without the notice required in § 1.199A-8(d)(3) the eligible taxpayer would not know that the Specified Cooperative is passing a portion of its section 199A(g) deduction to the eligible taxpayer.

The collections of information in § 1.199A-7(h)(3) are necessitated by a special transition rule in section 101 of the 2018 Act. Under this transition rule, the repeal of former section 199 for taxable years beginning after December 31, 2017, does not apply to a qualified payment received by a patron from a Specified Cooperative in a taxable year beginning after December 31, 2017, to the extent such qualifie

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