QPAI and Section 199 Deduction Do Not Roll Uphill to Federated Cooperatives

Two federated grain cooperatives - CHS Inc. and AGP - have asserted that Section 199 deductions roll up from the farmer-patron to the local cooperative and then to the regional cooperative. This view does not appear to be supported by any legal authority or by private letter rulings issued in the last twelve months.

At issue here is whether federated or local cooperatives control the tax deduction. Federated cooperatives understandably want to control the tax deduction, but the deduction properly belongs to the local cooperatives.

The attribution rule does not roll the QPAI up to federated cooperatives unless they buy directly from a producer of agricultural products. The statute - 26 USC 199(d)(3)(D) - says that a cooperative "shall be treated as having manufactured, produced, grown or extracted . . . [a]ny qualifying property . . . [m]arketed by the organization which its patrons (emphasis added) have so manufactured, produced, grown or extracted".

Treasury regulations do not (and could not) expand the statute's reach. 26 CFR 1.199-6(d) repeats the statute's specific focus on the Cooperative's patrons. Hence, the attribution rule stops the roll up of the QPAI at those cooperatives that buy agricultural and horticultural products directly from agricultural producers. These are the only cooperatives whose patrons are agricultural producers who manufacture, produce, grow or extract agricultural or horticultural products.

A federated cooperative does not generate QPAI from its purchases of agricultural products from local cooperatives because local cooperatives - who from the federated's point of view are its patrons- do not manufacture, produce, grow or extract in whole or significant part any agricultural or horticultural product. Many states with large agricultural footprints prohibit corporations - including local cooperatives - from owning farm land or "farming". Hence, by definition local cooperatives in these states could not manufacture, produce, grow or extract agricultural or horticultural products.

A local cooperative, on the other hand, generates QPAI because its patrons are producers that "manufacture, produce, grow or extract agricultural or horticultural products". When federated cooperatives purchase agricultural or horticultural products directly from agricultural producers, the federated co-op generates QPAI from those purchases, in the same manner that local co-ops generate QPAI from purchases of agricultural or horticultural products from agricultural producers.

Local cooperatives that wish to challenge any federated cooperative's usurpation of the local co-op's Section 199 deduction are invited to contact me.

Joel Dahlgren