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Market cloud: Tax 'fix' tips scales by 15 cents per bushel to co-ops

George Schuler IV, 28, is a co-owner and grain and logistics manager for Minn-Kota Ag Products, Inc., at Breckenridge, Minn. The company does business in North Dakota and Minnesota, and is expanding grain capacity to nearly 9 million bushels. Mikkel Pates / Forum News Service1 / 4
George Schuler IV, 28, is a co-owner and grain and logistics manager for Minn-Kota Ag Products, Inc., at Breckenridge, Minn. The company does business in North Dakota and Minnesota, and is expanding grain capacity to nearly 9 million bushels. Mikkel Pates / Forum News Service2 / 4
Min-Kota Ag Products, Inc., bin site in Breckenridge, Minn. Company officials dominate the landscape. The company has fourth-generation family leadership and has been around for about 80 years. Mikkel Pates / Forum News Service3 / 4
A grain truck unloads at Minn-Kota Ag Products, Inc., bin site in Breckenridge, Minn. Company officials worry that a tax reform package will influence customers to sell at co-op competitors, unless the provision isn’t fixed or they create their own co-op. Mikkel Pates / Forum News Service4 / 4

BRECKENRIDGE, Minn. — George Schuler IV, a co-owner and grain and logistics manager for Minn-Kota Ag Products Inc., is upset because of a tax law snafu that favors cooperative competitors over corporate grain companies.

Schuler says a "fix" in the federal tax reform bill in January has artificially and suddenly given a 15- to 20-cent-per-bushel advantage to his cooperative competitors in North Dakota and Minnesota.

Schuler says — if left unfixed — the so-called 199A effect will dramatically and unfairly cut his competitiveness at a time his company is spending millions to expand.

"The incentive to do business with the co-op is huge," he says. "This is a game-changer in the grain industry. It will reshape the grain industry and the farming communities forever if this law stays unchanged."

"G4," as they call him, is 28 and a North Dakota State University agricultural economics graduate. He's been six years full-time at MKAP, the fourth generation in the family-owned elevator. MKAP has an 80-year history in the business. It has nearly 6 million bushels in storage capacity and will increase to nearly 9 million bushels because of a facility under construction east of Barney, N.D. The company buys and sells grains from local farmers, as well as selling seed, chemicals and dry fertilizer. The company is a significant local player, but is "surrounded by cooperatives," Schuler says.

As a counter-move, MKAP is looking at setting up its own cooperative entity so that farmers can sell their grain and still get the tax advantage they'd get from established co-ops.

See also: Biggest co-op run since '20s? Accountants, lawyers get busy

"We never anticipated we'd have to do something like this," Schuler says, shaking his head.

He estimates it could cost $100,000 to get the job done and maintain it year to year.

A GOP issue

Sen. John Hoeven, R-N.D., was instrumental in ramrodding the co-op friendly amendment into law. The tax reform bill (formally the Tax Cuts and Jobs Act) was designed to cut taxes and simplify the code. The corporate tax rates were cut from 37 percent rate to 21 percent, and much more than personal rates. Permanently.

Hoeven answered the call when farmer-owned co-ops complained that their members would lose a so-called "Section 199" system, in which they had qualified for the "Domestic Production Activity Deduction." Members of co-ops like American Crystal Sugar could deduct up to 9 percent of their sales on their income tax. A loss of the provision could cost shareholders an average of $15,000 each, they said.

Hoeven and Sen. John Thune, R-S.D., pushed through a "Section 199A" provision into the final version. It more than doubled the deduction from 9 percent to 20 percent of sales. The provision sunsets in 2025, but theoretically could be extended.

Schuler recognizes that Hoeven now wants to rectify the matter.

"Everybody is on board," Hoeven said, Jan. 18. "We'll get it fixed."

Schuler was disappointed when it didn't happen on a Feb. 8 budget vote. On Feb. 21, U.S. Sen. Chuck Grassley, R-Iowa, had indicated Congress was "very close" to getting it fixed through a continuing resolution that's to be voted on March 23.

Stu Letcher, executive vice president of the North Dakota Grain Dealers Association, notes that on Feb. 21, 77 House members signed a letter, urging House leadership to fix 199A. The move was backed by the National Grain and Feed Association and the National Council of Farmer Cooperatives.

Schuler says the clock is ticking.

"We've seen significant rallies in the marketplace in the last two weeks," Schuler says, glancing up at an impressive bin complex that dominates on Eighth Street in Breckenridge. "Are we missing out on this business to local cooperatives? We could be."

Like a cloud

Randy Martinson, president of Martinson Ag Risk Management in Fargo, says some of his clients are holding up making sales as they determine whether the equity will be restored between co-ops and private companies.

"We're in a timeframe when producers should be looking at making some sales at this time," Martinson says. He estimates that about 25 of his clients — maybe 10 percent of the total — have brought up the subject on their own, meaning many more are thinking about it.

He thinks it's creating something of a "slow movement" in grain, despite market improvements.

Some will take the easy route and sell at a co-op, not being able to predict what Congress will be able to do, Martinson says.

"It's basically going to be the next six weeks," Martinson says. If it isn't fixed, it'll be July before grain movement resumes. He is skeptical that there will be a "fix," but thinks it's likelier that they'll "give the incentive to both sides."

Frayne Olson, a North Dakota State University professor of agricultural economics, serves as an Extension Service grain marketing specialist. He also wears a hat as director of the Quentin Burdick Center for Cooperatives, putting him in a perfect position to understand the implications of the snafu.

The original 199 tax provision initially was a kind of trade policy and favored "domestic producers." The 199A fix was created with co-ops like sugar beet processors but didn't anticipate subtle differences among co-ops.

Process-based farmer cooperatives don't operate exactly the same as marketing-based co-ops.

For example, sugar beet processing cooperatives are "closed" co-op that only buys beets from its own members.

Beet co-ops announce per-ton raw beet "payments," to members but technically don't "purchase" raw beets. Instead, they process and sell the sugar and subtract out processing expenses. The "remainder goes back to the farmer in the form of a payment, based on the tons and quality of beets delivered. A portion of that payment is then held back ('unit retains') for financing the company as a whole," Olson says. Ditto for dairy processing co-ops like Land O'Lakes.

To compare, a co-op grain marketing co-op is an "open" co-op. It buys grain from any number of farmers, resells it to a buyer, subtract the expenses. That net profit is returned to the farmer in the form of "patronage" earnings.

Co-op majority

Olson says there are about 160 grain marketing cooperatives in the state of North Dakota. In the northern Great Plains, cooperatives handle more than half of the grain shipments. Letcher estimates roughly 60 to 65 percent of the grain in the state is currently marketed through cooperatives.

If unchanged, if a farmer sells $1 million in grain to a cooperative, they can take 20 percent of that — $200,000 — as a deduction to their taxable income.

"My personal opinion is, I do think we'll have some kind of fix, some changes made to the law," Olson says. He also thinks the fix will "still be a 199A," but with limitations and restrictions, and be retroactive to Jan. 1, 2018.

"The longer it goes, and the more this grain flows through the system and the more people who have been using this (tax benefit), the harder and harder it gets to make it retroactive back," Olson says. "If you've already been selling grain through a cooperative, trying to get this tax benefit, it may or may not be available."

But Olson thinks the benefits will not be as large as the 199A fix would have provided.

"I think they're going to try and equalize it out," he says.