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IRS Offers Coops Guidance on Section 199 Deduction in Short Years
In August, the IRS put to rest the long-standing question of how W-2 wages are determined when a taxpayer has a short taxable year.
The guidance is important to agricultural cooperatives for a couple reasons. Many cooperatives’ Section 199 deductions are limited by W-2 wages because the qualified production activity income (QPAI) and taxable income are higher than the wage limitation due to QPAI and taxable income being computed without taking into account any deduction for patronage dividends, per-unit retain allocations, and non-patronage distributions. Also In recent years, an increase in mergers and acquisitions in the cooperative industry has created a “short year” (a fiscal or calendar year less than 12 months) for many cooperatives, which this guidance also addresses.
Section 199 deduction
The amount of the Section 199 deduction for any taxable year cannot exceed 50 percent of the taxpayer’s W-2 wages. W-2 wages are defined as the total amount of wages plus compensation deferrals and elective deferrals paid by the taxpayer to employees for the entire calendar year ending during the taxpayer’s taxable year. (The amount of wages is generally equal to Box 5 on Form W3.) For example, a taxpayer with an August 31, 2015, year-end would include W-2 wages for the calendar year ending December 31, 2014.
How to report in a short year?
Historically, the IRS did not provide clear guidance for taxpayers with a short taxable year, which has been problematic for taxpayers as well as practitioners when determining the W-2 wage limitation.
The temporary regulations have now addressed this issue. They state that in the case where one or more taxpayers may be considered the employer of employees of an acquired or disposed of business during the calendar year, the W-2 wages paid during the calendar year to employees are allocated to each taxpayer based on the period the employees worked for them.
In the case of a taxpayer with a short taxable year in which there is no calendar year ending, wages paid during the short taxable year are treated as W-2 wages. For example, if a taxpayer was acquired on October 1 following its June 30 taxable year, the wages paid to employees from July 1 to September 31 would be included as W-2 wages for purposes of Section 199.
The regulations also describe transactions that are considered either an acquisition or disposition for purposes of the Section 199 deduction. These transactions include incorporation, formation, liquidation, reorganization, or a purchase or sale of assets. These regulations are set to expire on August 24, 2018.
How we can help
CLA’s professionals combine their understanding of issues that affect cooperatives with significant tax resources. Applying this knowledge is particularly relevant when working with the Section 199 deduction in short years or when taxpayers have been involved in an acquisition.