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IRS Addresses Calculation of Cooperative’s Section 199 Deduction
The IRS recently issued a letter ruling that addresses the interplay between the subchapter T rules concerning the taxation of cooperatives and their patrons and the calculation of a cooperative’s section 199 deduction.
PLR 200838011, dated June 18, 2008, and released September 19, 2008.
The IRS concluded because section 199(d)(3) allows certain payments from a cooperative to its patrons to be added back for purposes of computing the cooperative’s deduction under section 199, an agricultural cooperative must include all “net proceeds” payments or allocations made to its patrons—including amounts that are advanced to its members and the final patronage dividend—in the cooperative’s computation of the section 199 deduction. The IRS stated that the advance amount is considered a “per-unit retain paid-in money” (PURPIM) under section 1382(b)(3).
For an electronic version of the eight-page letter ruling:
PLR 200838011
KPMG Observation
This ruling—in which KPMG assisted—provides useful guidance to cooperatives and their patrons in the computation of the section 199 deduction. In February 2008, the IRS issued an Internal Legal Memorandum (see
TaxNewsFlash-Cooperatives 2008-01) which reached a similar conclusion.
In certain industries, the practice has been to capitalize, for both book and tax purposes, some of the payments to members as part of the inventory of the cooperative. But under the marketing agreement, the cooperatives are required to pay the “net proceeds” to the members. Thus, although the advances appear to be a fixed payment to the members, they are in fact not under the marketing agreement. At the end of each fiscal year, the cooperatives close the books and pay a final payment (i.e., patronage dividend) to the members. Thus, the cooperatives makes full “net proceeds” payments in the form of the advances during the year and the patronage dividend at the end of the year.
The recent IRS ruling confirms that both the advance payment (known as the “c Check” in the ruling) and the patronage dividend are added back for purposes of determining the section 199 deduction. It also confirms that this is the
exclusive method for computing the section 199 deduction. These results mean that the members cannot use the receipts from the cooperative in their own section 199 deduction computation, but can only take the pass-through from the cooperative on his/her individual return.
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Overview
An agricultural cooperative and its wholly owned subsidiary process and market products for its member farmers.
Under the cooperative arrangement, the farmers deliver their farm products to the cooperative which, in turn, transfers the product to the subsidiary for processing and markets the resulting products. At the end of each year, the subsidiary computes its net proceeds and distributes the patronage income to the parent cooperative for distribution to its members. While the cooperative must distribute the net proceeds on a patronage basis, a portion of the net proceeds are capitalized (known as the “c Check”) into inventory.
The “net proceeds” of the cooperative are defined under the agreement as the proceeds remaining from sale of the products, after deducting all costs, expenses and charges; however, none of the payments to the members is included in the “net proceeds” computation.
The cooperative makes annual payments to its patrons each year. Also, amounts are advanced to the members one or more times a year. These advance payments are known as the “c Check” (treated as “per-unit retains paid in money” (or PURPIMs)) and keep the cooperative competitive with non-cooperative processors. At the end of the year, the cooperative distributes the remaining amount of net proceeds to the patrons. The final payment is considered a “patronage dividend” for federal income tax purposes, with at least 20% paid in cash and the remainder in qualified written notices of allocation for the full amount to be deductible by the cooperative and includible in the income of the patrons.
Concerning the amount of the cooperative’s section 199 deduction, the IRS ruled that the section 199 deduction is computed at the cooperative level and that none of the distributions—whether patronage dividends or per-unit retain allocations received from the cooperative—are eligible for section 199 in the patron’s hands. In other words, the patron may not count the qualified payment received from the cooperative in the patron’s own section 199 computation whether or not the cooperative keeps or passes through the section 199 deduction.
The IRS continued to explain that the only way that a patron can claim a section 199 deduction for a qualified payment received from a cooperative is for the cooperative to pass-through the section 199 amount under the provisions of 199(d)(3).
For more information, contact KPMG’s National Director of Cooperative Tax Services:
Teree Castanias, in Sacramento, (916) 554-1146,
tcastanias@kpmg.com
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