n Oct. 22, President
Bush signed into law the
American Jobs Creation
Act of 2004. The primary
impetus for the new
law was a World Trade Organization
(WTO) ruling that certain export tax
benefits in our existing tax code violated
international trade agreements we
had signed. The WTO authorized
European countries to collect special
tariffs on American products they
imported, until we repealed those
export tax benefits.Second, the QPAI deduction may not exceed 50 percent of the W-2 wages paid by the taxpayer for the year.
Cooperative Pass-through Provision The report of the conferees who drafted the final version of the law makes it clear that income derived from manufacturing, production, growth or extraction of any agricultural or horticultural product by a cooperative, or from marketing agricultural or horticultural products by a cooperative, may be included in the cooperative’s QPAI. A note to that report states that the term “agricultural or horticultural product” includes “fertilizer, diesel fuel and other supplies used in agricultural or horticultural production that are manufactured, produced, grown or extracted by the cooperative.”
The law provides that patrons of agricultural and horticultural cooperatives can take a deduction on their tax returns for QPAI allocated to them as part of a qualified patronage refund or qualified per-unit retain. The amount each patron can deduct must be computed by the cooperative and a written notice must be provided each patron explaining the computation.
A special rule says a cooperative may not take a patronage refund deduction for amounts passed through to patrons that can be deducted by those patrons. As this amount is already eligible for the QPAI deduction at the cooperative level, this language merely makes it clear cooperatives can’t deduct the same amount twice.
Example case
This example illustrates how the deduction and the pass-through might work at a typical agricultural or horticultural cooperative. Assume Co-op C has $100,000 of QPAI. Also assume it is a tax year beginning in 2005 or 2006, so the available deduction is 3 percent of QPAI, or $3,000.
Co-op C allocates the $100,000 to its member-patrons as a qualified patronage refund. It is allowed to deduct the $3,000 in QPAI under the new law and the remaining $97,000 as a traditional patronage refund. Thus, the result is the same for the cooperative as it was before the new law was enacted, the entire $100,000 is deductible.
Now, assume Patron P does 10 percent of the business with Co-op C in the tax year. Patron P receives a patronage refund of $10,000 in QPAI, all of which is taxable income to Patron P. However, under the new law Patron P can deduct the applicable percentage of QPAI (3 percent in 2005 and 2006), or $300. The value of this benefit will increase significantly when the QPAI deduction increases to 6 percent in 2007 and again to 9 percent in 2010.
Another provision states that any qualifying activity of patrons who market agricultural or horticultural marketing through a cooperative may be attributed to that cooperative for purposes of computing its QPAI deduction.
Planning suggestions
Here are some points to remember in planning how best to use this new deduction. First, the legislative language is not always entirely clear. Tax experts have many unanswered questions about determining what income is eligible for the deduction. So, all cooperatives will want to work with their tax adviser to keep abreast of Internal Revenue Service rulings and other interpretations of this program.
Second, the deduction is first available for tax years beginning on, or after, Jan. 1, 2005. Many cooperatives on a tax year that begins sometime in the summer or fall will thus have nearly two years to become familiar with the intricacies of computing and allocating it.
Third, it is a deduction, not a credit. Tax credits, such as the energyrelated credits discussed later in this article, can be used dollar-for-dollar to offset taxes due. Deductions can only be used to reduce taxable income, so their value depends on each taxpayer’s tax bracket.
Dividend Allocation Rule repeal
The dividend allocation rule was an Internal Revenue Service (IRS) interpretation of the tax code requiring cooperatives that paid dividends on their equity investments to allocate those dividends on a pro rata basis between their patronage and nonpatronage income. Under the new law, cooperatives can pay dividends on stock entirely out of non-patronage income. This allows cooperatives to reduce the tax cost of paying dividends on their equity investments and, at the same time, return more of their margins to patrons as patronage refunds.
To take advantage of this change, the new law requires cooperatives to have appropriate language authorizing them to pay stock dividends out of non-patronage income in their articles of incorporation, bylaws or marketing contracts with their members and other patrons. Many cooperatives will want to amend one or more of these organizational documents to include such a provision.
Declaratory Judgment relief Farmer cooperatives that want access to the special tax deductions permitted under Internal Revenue Code section 521 and other benefits that come with section 521 status, must apply for, and receive, approval from IRS. In the past, the only ways a cooperative could get a court to review a rejection of its application was claim a deduction IRS said they weren’t entitled to, or pay some tax they didn’t think they owed and then sue for a refund. This provision enables a farmer cooperative to seek judicial review of the denial without first creating a tax controversy or being subject to immediate tax liability.
Marketing includes value-added
processing involving animals
One of the activities that allows a farmer cooperative to qualify for section 521 tax status is to engage in “...marketing the products of members or other producers.” IRS interpreted this language to include value-added processing involving a mechanical process (converting corn to ethanol) but not a biological process (feeding corn to hens and selling eggs and chickens).
The new law makes it clear that under both section 521 and regular cooperative tax rules, marketing products of members and other producers includes feeding products of members and other producer to cattle, hogs, fish, chickens or other animals and selling the resulting animals or animal products.
Small ethanol producer
credit, co-op pass-through
Current law provides a 10-centsper- gallon tax credit for each gallon of ethanol produced and sold by so-called small ethanol producers, including cooperatives. These are companies with production capacity that does not exceed 30 million gallons of ethanol per year. The credit can be claimed on production of up to 15 million gallons of ethanol per year.
The new law allows cooperatives to choose to pass some or all of the small ethanol producer credit through to their patrons. The credit is to be apportioned among patrons on the basis of the quantity or value of business done with, or for, such patrons during the tax year. Any credit not passed through to patrons is treated as a general business credit by the cooperative.
Small, low-sulfur diesel fuel
producer credit, co-op pass-through
The act creates a new, 5-cents-pergallon tax credit to small petroleum refiners who must incur capital costs complying with the Environmental Protection Agency’s rules limiting the sulfur content of diesel fuel. Eligible refiners may claim the credit until they have recovered 25 percent of such costs. For these purposes, a small refiner is one that employs not more than 1,500 persons directly in refining and has less than 205,000 barrels per day (average) of total refining capacity. The credit is reduced for refiners with a capacity between 155,000 and 205,000 barrels per day. The conferees’ report states that when capacity “differs substantially” from average daily output of refined product, capacity should be measured by reference to average daily output.
Cooperatives may also choose to pass some or all of this credit through to their patrons. As with the small ethanol producer credit, any passthrough is to be apportioned among patrons on the basis of patronage and any credit not passed through to patrons is treated as a general business credit by the cooperative.
