This article addresses a suggestion for reporting your patronage dividends income for the 2019 tax year. Please keep in mind the caveat that this is not individual advice and you need to explore all of the nuances of the tax law and your particular tax situation. Your tax software or tax preparer can help with that. Below the discussion for 2019 is a review of self-employment tax and patronage dividends as well as a summary of the experience with the IRS for 2018. This second section is optional and not needed for 2019 tax reporting.
Tax Reporting for 2019
The 2019 income tax filing is the second year of following the revised income tax rules that include a new tax break for business owners with Qualified Business Income (QBI). With one year of experience with the new tax law, we have seen that it is complicated but how it works for co-op members is clearer. In addition, the IRS has now provided a group of forms (8995) to make reporting easier.
As a worker co-op member, you are a business owner and may qualify for this tax break on your 1099-PATR income. Please be sure that you complete your personal income tax forms to see if you can claim this tax break. The IRS Code Section allowing this tax break is 199A(c)(3)(B)(ii) which is confusing at first but clearly allows 1099-PATR income as QBI. If your tax preparer has not heard of this before just say: “Well clearly IRC 199A(c)(3)(B)(ii) says that patronage dividends qualify.”
There continues to be no clear guidance on where to report the income from a 1099-PATR for a worker co-op owner on a personal tax return. There are two options to consider. The first should result in fewer possible issues but either will work. Which you use may depend on how you or your tax preparer can get the tax software to work. Tax professionals generally use very flexible software that can certainly do all of this reporting. If your taxes are otherwise complicated you can leave all of this to someone else. But if your taxes are fairly simple you should be able to prepare your own return and still receive the QBI tax break.
For more discussion of this 20% QBI deduction, there is another article on our blog explaining more about this aspect of the 2018 tax law.
If you are using your own tax preparation software the first step to consider is that you will not report your 1099-PATR with the 1099-INT or 109 9-DIV reporting. The default treatment of a 1099-PATR is to report it on Schedule F (for farmers) or Schedule C. Option 2 outlines this option if you want to use it. After the Option 2 discussion, I review the issues with patronage dividends and self-employment (SE) tax as well as dealing with the IRS if you get notice. You can skip those last sections if you like.
Option 1 – Report as Other Income
The 1099-PATR income should be shown as Other Income reported on Form 1040, Schedule 1, Part I, Line 8. You should report it as “1099-PATR profits from” your co-op and list the co-op’s Tax Payer Identification Number (TIN). If your co-op’s name is Co-op Blue and the TIN is 99-1234567, then use this description for Form 1040, Schedule 1, Part I, Line 8: “1099-PATR profits from Co-op Blue, 99-1234567”. The amount of the 1099-PATR income reported as Other Income will flow to the front page of the 1040, Line 7a adding to taxable income from other sources.
In addition to reporting on the Other Income line, you need to report the 1099-PATR income on Form 8995. This is the form that allows you to claim the QBI tax break. There are related forms you may need to use in certain circumstances. These are 8995-A, and Schedules A to D of the 8995-A. For most worker owners the 8995 is all you will need. Your tax preparer or software should alert you if you need the 8995-A form and schedules. The information from your 1099-PATR will be reported on line 1 of the 8995. As on the Other Income line, you should describe it as: “1099-PATR profits from Co-op Blue, 99-1234567” and enter the dollar amount from the 1099-PATR. The Form 8995 will calculate your QBI and then the 20% deduction. If you do qualify for the deduction it will flow through to Form 1040, Line 10, reducing taxable income.
The Form 8995 summarizes your Qualified Business Income (QBI), so if you have other qualifying income, such as Schedule C income for a non-co-op business you have, it will also be reported on the 8995.
To get this to work with your tax preparation software you may need to enter an over-ride for Form 8995. If that does not work you can move to Option 2. Be sure to delete everything you have done so far in the tax software so you are not double counting your income.
Option 2 – Report on Schedule C-EZ
The alternative reporting for 1099-PATR income is on Schedule C-EZ which is also where sole proprietorship businesses are reported. On Schedule C-EZ use the principal business description of “1099-PATR profits from Co-op Blue” , specify that the business code is 999999 as “unable to classify”, and then use the Co-op’s Employer Identification Number (EIN) as the EIN for Schedule C-EZ.
Enter the income amount for Schedule C-EZ as the dollar amount reported on the 1099-PATR.
Do not take any deductions or mix in any other business activities. Doing so will nullify the assertion that the 1099-PATR income is not subject to the SE tax.
In order to avoid the SE tax you may be able to specify that the Schedule C-EZ is not subject to SE tax. Professional software will have this option. If this is not available go to the Schedule SE and enter an adjustment to offset the 1099-PATR income. This will be a negative number equal to the positive number entered on Schedule C-EZ. Check that the taxable amount on Schedule SE is zero after doing this.
The Schedule C-EZ income should automatically flow through to the Form 8995 and result in the 20% QBI deduction. There are potential exceptions where the QBI gets more complicated as noted in Option 1. These are primarily based on your total income. Your tax preparer or software should prompt you to explore those.
Patronage Dividends and the Self-Employment Tax
Below I will discuss why the 1099-PATR income generally does not belong on the Schedule C and why, if it is reported there, it should not be subject to the Self-Employment (SE) tax. SE tax is the Social Security and Medicare tax imposed on profits from self-employment at the rate of 15.2%.
One initial consideration is that if the 1099-PATR is $400 or less there is an exemption from SE tax. This will apply if you do not have any other self-employment income.
The contention of many worker co-op owners, as well as attorneys and accountants working with worker co-ops, has been that the 1099-PATR should not be subject to the SE tax. For a detailed discussion of the patronage dividend and SE tax issue please see the article written by attorney Gregory Wilson.
The key issue is that if the 1099-PATR income is payment for services it is subject to SE tax but if it is a payment of business profits it is not subject to SE tax. If your W-2 wage is fair compensation for your services then an argument can be made that the 1099-PATR is a payment of profits. There are many possible factors involved in this determination of fair compensation and we will not consider those here.
Some attorneys have been trying to get the IRS to agree that all worker co-op 1099-PATR income should not to be subject to SE tax but the IRS has declined to accept this interpretation. A legislative solution seems like the only way to resolve this but there is currently no action on this issue. The conclusion is that for now there continues to be a risk of a challenge from the IRS if you classify your 1099-PATR as not subject to SE tax.
What to Do if Contacted by the IRS
Whichever option above you use there is a chance the IRS will contact you to ask why you did not pay SE tax on your 1099-PATR income. That is more likely with Option 2 but it is not a certainty that you will receive a notice. In any case, don’t panic. But you do need to respond as soon as you can. There is a page on the USFWC website with some resources to help including a template letter for a response to the IRS. Check it out here.
The experience of everyone I heard from who used the template letter, or some version of it, is that the IRS accepted that the SE tax did not apply. Any refunds were released. The IRS did not respond with a notice indicating that the case was closed. But with the under-funding and under-staffing of the IRS this lack of a follow-up response is not uncommon in the last few years.