Section 199 Articles
Section 199 Amended Returns
By: Chris Coldiron, CPA, Tax Manager | email
The case for Section 199 amended returns continues! The first pre-settlement appeals conference with the IRS Appeals Office is scheduled for August 8th and 9th. Please be aware that if you filed an amended return to claim an enhanced Section 199 deduction and have not heard from the IRS, please contact us so that we may follow up on and track the status of your amended return.
Cooperatives and Current Year Earnings
By: Dennis Gardiner, Partner | email
What are you going to do with this year’s earnings?
We continue to have discussions, at all levels, with our cooperative clients on how to handle current year earnings. We have been attempting to have these discussions long before fiscal year-ends so that management has some direction from the board on how they would like to see it handled.
We have been laying out some of the options available to cooperatives at the end of the year. These include:
• Qualified patronage allocations
• Non-qualified patronage allocations
• Keeping or allocating the benefits of Section 199
• Using bonus depreciation, or not.
Any one, or any combination of these, can be used at year-end to distribute earnings or to mitigate tax liabilities. In fact, the number of options can be confusing, and require analysis as to the impact on current and future year decisions.
Our main focus has been the built-up retained earnings that so many of our cooperative clients have. As we have asked before, how much is too much? Unfortunately, we have not answered that question yet. Obviously, every coop is going to be different.
The dilemma is that Section 199 and bonus depreciation are effective ways to mitigate taxes, but they tilt the imbalance in member’s equity further towards retained earnings. We are trying to address this with our coop clients so that decisions are made with an understanding of how they affect members in the current and future years.
Furthermore, we are exploring ways to address one of the central concerns we have heard, which is, “what happens if the coop were to be sold, or some company were to come in to try to buy the coop?” The solution to this may take revisiting articles of incorporation and by-laws, working with legal counsel and analyzing how retained earnings has grown to today’s levels.
Please contact us at your convenience to discuss what options your coop has, how to present the choices the board will have at year-end, and the effects of those choices.
Cooperative Trends Expected in 2011
By: Dennis Gardiner, Partner | email
What we expect to see in 2011…
- Use of 100% bonus depreciation.
- Continued investments in capital improvements, particularly grain storage.
- More interest in non-qualified patronage allocations.
- With the quick build-up over the past few years of retained earnings, we anticipate seeing more time spent in the board room or board retreats addressing the member’s equity mix of the cooperative’s balance sheet.
- Considerable time and money being spent in complying with OSHA standards.
Cooperative Trends of 2010 – What We Have Seen
By: Dave Thomsen, Partner | email
What we have seen in 2010…
- Clients were more profitable in 2010 compared to 2009. Depending on year end, local savings was much better in 2010 than 2009, but not back to record 2008 levels.
- Increased grain and agronomy volumes, lower prices.
- Agronomy margins improved and were closer to historical averages, prices stabilized.
- Wet 2009 harvest led to substantially higher grain drying revenues in 2010, however grain quality became an issue.
- Clients with November 2010 through January 2011 year ends saw an excellent fall fertilizer season that will increase local savings.
- With lower prices, borrowing was down, and with low interest rates, interest expense was down, sometimes less than half of 2009 totals.
- Accounts receivable ageing generally improved.
- Build, build, build! Many clients spent substantial dollars for fixed asset additions, primarily grain and liquid fertilizer storage facilities. It appears these additions have been good investments.
- The recent trend to build retained savings and the company’s balance sheet continued, aided by the benefits of the gross domestic production deduction (Section 199).
- More clients began to allocate the benefits of Section 199 to their patrons. This was largely caused by the cooperative’s inability to use all of the benefit due to lower earnings.
- Some clients have begun to allocate a mix of patronage and Section 199.
Section 199 Amended Return Update
By: Gardiner Thomsen CPAs | email
We have recently received verbal notification from the IRS that all amended returns which have been filed to claim the increased section 199 deduction will be disallowed, and to look for formal written notification of this decision by the end of September. Our hope is that the IRS will be specific as to why these amended returns have been disallowed, so that we will be able to challenge the veracity of the IRS action. Once we have the opportunity to assess the formal IRS position, we will be able to suggest the appropriate strategy for our clients. Generally speaking, the next step would be to appeal the IRS disallowance on a coop by coop basis.
The appeals department of the IRS is separate and totally independent from the audit department. We will have the opportunity to present the evidence we have which we feel authorizes the filing of these amended returns and directly refutes the IRS reasons for their initial disallowance. We remain confident that our position will be upheld and that the amended return claims will be processed and paid. We are also confident that our section 199 strategy for current returns appears to be unaffected by this upcoming IRS action.
In the meantime, we will determine whether or not to continue filing amended returns. To briefly explain, a taxpayer generally has a 3 year window in which to file an amended return. After 3 years, that ability is lost. So, a calendar year cooperative with a December 31, 2006 tax year would have until September 15, 2010 to file an amended return. Our policy has been to file these amended returns generally as the statute comes due, to make sure we have the latest IRS information prior to filing, and still file prior to the statute expiring.
Until this issue is resolved, we want to evaluate each coop’s situation to determine if filing amended returns are in your best interest. We now know to expect IRS scrutiny of your amended return, so we will factor that into the decision to file a particular return as well.
We will continue to monitor this situation and work closely with you to take the most appropriate action for your cooperative.
Allocating Patronage Under Section 199
By: Gardiner Thomsen CPAs | email
We would like to inform you of some important points to keep in mind if you plan on allocating some or all of your patronage sourced section 199 deduction to your members.
You have to provide written notice to your members, just like you would regarding their patronage allocation. This notice must be provided within 8 ½ months of your cooperative’s fiscal year end. Members will generally be able to deduct their allocated portion of the section 199 deduction in the year in which they receive notice. So, if your cooperative has an August, 2010 fiscal year end, and decides to allocate your section 199 deduction to your members, if you provide notice prior to December 31, 2010, your members have a 2010 deduction. If your notice is after December 31, 2010, but prior to May 15, 2011 (the 8 ½ month deadline), then your members would have a 2011 deduction. Timing is very crucial.
In addition to the written notice, you must also report the allocation of your patronage sourced section 199 deduction that is allocated to your members on form 1099PATR. This can be confusing because many cooperatives have a non-calendar fiscal year end, whereas 1099 reporting is based on calendar year figures. In our above example, if notice is provided prior to December 31, 2010, then this allocation would go on a 2010 1099PATR. If notice is given after December 31, 2010, but prior to May 15, 2011 (the 8 ½ month deadline), then the allocation would go on a 2011 1099PATR.
Remember, even if your cooperative is allocating all or part of its patronage sourced section 199 deduction to your members, you still have to report Per Unit Retains Paid in Money (PURPIMs) to your patrons on form 1099PATR.
These reporting issues can be very confusing. Please contact us if you have any questions regarding patron notification or 1099 reporting.
Shark Repellents and Poison Pills
By: Dennis Gardiner, Partner | email
Now how do these terms fit into the Coop world? Actually, they are quite timely. Our clients have built their retained earnings quickly over the last few years, particularly as they utilize the benefits of the Section 199, Domestic Production Activities Deduction, to eliminate or lower the income taxes associated with a large portion of what has been retained.
As we visit our clients this year, we have found ourselves discussing retained earnings, qualified patronage, non-qualified patronage and retaining or allocating the benefits of Section 199. The topic of how much retained earnings is appropriate keeps surfacing as well. One of the concerns that comes up is how the proceeds of a sale of the company would be distributed if the company were to sell. And, with the retained earnings being significant relative to the equity in the names of the members, the concern turns to how vulnerable the cooperative is to an offer that could be perceived as attractive to the members but would end up being a discounted sale of the coop– one heck of a bargain for a buyer.
Shark repellents and poison pills are some of the defensive mechanisms that are designed to make a potential acquirer deal with the board of directors. Shark repellents reduce the desirability of the company and are used to stall the transfer of control over a period of years once the acquiring company has acquired a majority of the shares of the company they are trying to buy (target). The idea is that the company will be continually less desirable to the potential acquirer the longer they have to wait for control once they acquire a majority of the target company’s shares.
A poison pill is one of the defense mechanisms in another class of anti-takeover provisions that makes it difficult, or impossible, to acquire the necessary shares of the target company regardless of the desirability of the company.
What can your cooperative do to protect itself in an unsolicited take-over situation or in a friendly sale of a control transaction? The first step would be to engage an attorney who can advise you on a specific situation and ensure that the board’s actions are not likely to result in legal consequences later.
An unsolicited offer brings with it a plethora of practical and legal considerations. It is important for cooperatives to have in place defense mechanisms before an offer is made that will enable the board of directors to act as a buffer between the acquirer and the shareholders. With the success of many of our clients over the past several years, now might be as good as time as any to look into what would happen if another company set its sights on your cooperative.
Source: 2009 Summer edition of the NSAC’s “The Cooperative Accountant” written by David P. Swanson, Dorsey & Whitney LLP and Charles L. Woltmann, Sunkist Growers, Inc.
National Coops Look To Take Advantage of Section 199
By: Dennis Gardiner, Partner | email
With their letter dated August 19, 2009, AGP announced their intent to take advantage of the enhanced section 199 deduction effective with their current fiscal year ended August 31, 2009. They will now be computing their section 199 deduction in accordance with the prescribed manner that Gardiner Thomsen brought to you last year.
The question is now, how will this affect your cooperative tax return?
The fact is, as we discussed last year, whether or not a cooperative adds PURPIMs back to their taxable income for computing section 199, those PURPIMs are NOT qualifying gross receipts to the member recipient for purposes of the member computing their own section 199. In other words, even if a cooperative does not claim the enhanced deduction, member grain payments are still PURPIMs to those members. This precludes members from considering these as qualifying domestic production gross receipts when making their section 199 calculation.
AGP’s actions will have the effect of reducing a cooperative’s qualifying domestic production gross receipts. However, remember that the section 199 deduction is limited to one-half of your qualifying wages. As we discovered last year, our clients’ section 199 deductions were reduced to this limitation in almost every case. What this means is that a cooperative could reduce its qualifying domestic production gross receipts to the point where the computed deduction equals the 50% of qualifying wage limitation without experiencing a decrease in their section 199 deduction. When one considers that the domestic production activities income percentage is increasing from 6% to 9% next year, a cooperative could reduce its qualifying domestic production gross receipts because of grain sales to other cooperatives of which it is a member, without reducing any section 199 deduction due to the 50% wage limitation. Also, remember that any sales your cooperative makes to a non-cooperative are not affected by this IRS rule.
Furthermore, the AGP letter indicates that they intend to pass “most or all” of their section 199 deduction to their members for their fiscal 2009 year. Because an allocated section 199 deduction is treated differently than a cooperative’s computed section 199 amount (remember, nothing is ever easy with taxes and the IRS), you could very well have a situation where your computed section 199 deduction is not reduced for the reasons discussed above, yet because of your share of AGP’s section 199 allocation, your actual usable section 199 deduction is increased.
You will still be able to deduct your allocation of AGP’s 199 deduction in the tax year that you receive notice. I would imagine that you will receive a letter from AGP announcing your portion of the AGP section 199 allocation. This amount will then be reported on box 6 of your 1099 PATR form that you receive in January for the prior calendar year’s business. If you receive this notice in 2009, then your 2009 1099-PATR will report this figure. If you don’t receive notice until 2010, this allocation will not be reported to you until you receive your 2010 – 1099 PATR in January 2011.
AGP’s letter goes on to say that they may ask the IRS to permit them to change the way they compute their ending inventory. We have previously touched on this issue. As AGP says, this would create a significant one-time cost of goods sold deduction in the year of change. We have analyzed this situation for some of our clients. This significant one-time deduction would most likely create a large operating loss that can be carried forward. Because of how section 199 is deducted, this large loss carry-forward would most likely allow AGP to continue to pass their section 199 deduction through to the members. We are hypothesizing a bit here, but the fact patterns could easily support such an action.
Although we have not seen anything in writing, we have heard rumors that CHS is also considering computing the enhanced 199 deduction. If they do, the same rules discussed above would apply.
The bottom line at Gardiner Thomsen is that we will continue to aggressively monitor and implement where appropriate, IRS rules and rulings in the best interest of our clients. Should you have specific questions or concerns regarding AGP’s letter or would like to discuss the possibility of CHS following suit, please do not hesitate to give us a call.
Another Opportunity To Save BIG!
By: Charles L. Telk Jr., CPA, Senior Tax Adviser | email
To anyone who thinks that cooperative taxation is a boring area, we say that you are grossly mistaken! Increasing the amount of money that section 199 has saved your cooperative is not boring– it’s exciting! Although, we are accountants and do realize that our idea of exciting is not always mainstream… however saving money is almost always exciting– especially BIG money!
In addition to computing how section 199 will benefit your cooperative this tax year, and investigating the benefits of amending past years’ returns, we are also working on (what we call) the section 1383 zero inventory issue.
The logic is, if a grain payment (for Federal income tax purposes) is not a purchase, then it is not inventory. And if it is not inventory, then you cannot have inventory. If you cannot have inventory, then your ending member grain inventory must be zero for Federal income tax purposes!
While this is somewhat confusing, we have heard that a “Big 4” international firm is filing cooperative tax returns making this argument. In fact, they may even have contacted you regarding this issue. What’s the point? With no ending inventory, you would have a tax deduction roughly equal to your GAAP basis member grain ending inventory– in other words, a tax deduction many times larger than your section 199 deduction. This could potentially mean tens of millions of dollars in savings. That is a big number.
So, what is the benefit? This could allow your cooperative to pass the section 199 deduction through to your members, which enhances their cooperative patronage. This could allow the cooperative to reduce its qualified patronage allocation, which allows the cooperative to retain equity, thereby strengthening the balance sheet. And there is no question that it would generate a Federal Net Operating Loss which can be carried over for 20 years (under current law) which would provide for virtually unlimited income tax planning to minimize your Federal (and in some cases State) income tax. In laymen’s terms, it would generate additional working capital for the cooperative– potentially an increase in working capital of millions of dollars.
We are in the process of evaluating how this issue applies to your cooperative. Rest assured that we at Gardiner Thomsen continue to investigate ways in which to save our clients as much tax (and therefore cash) as is legally possible. Please contact us at any time to discuss these exciting tax issues. We look forward to working with you.
Enjoy This Deduction While It Is Available.
By: Charles L. Telk Jr., CPA, Senior Tax Adviser | email
As we all know, tax laws change frequently. Under current law, we can compute and deduct (or allocate to your members) this section 199 deduction. In fact, this deduction even increases for tax year 2009 to 9% of adjusted taxable income before PURPIMs and allocated qualified patronage (currently 6%).
With the new administration in place, tax publications are speculating on what changes may be in store for the taxpaying community. Many of these publications are of the opinion that this section 199 deduction will be eliminated in its entirety. At this point, it is not possible or even reasonable to speculate– so our advice is to maximize your utilization of this deduction while it is available. And right now, it is available.
Another point to consider is, if your cooperative sells grain products to a Regional Cooperative, your deduction may be somewhat limited. We have heard that some of the large Regional Cooperatives are now investigating taking this enhanced deduction. If so, then you would not be able to claim the grain payments received from them as Qualified Domestic Production Gross Receipts (just like your members cannot count their grain checks received from you).
Again, the message is to maximize these deductions while they are available. Should you be notified that a Regional Cooperative is now making this calculation, we will be able to determine what effect, if any, this has on your deduction. The silver lining is that, because your deduction is limited to 50% of your qualified wages, it is possible to reduce your taxable income limitation calculation without reducing your deduction. This is a complicated issue, so please contact us if you have any questions.