![Page 1: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/1.jpg)
Unit VI.
Income Taxation of
Co-ops
![Page 2: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/2.jpg)
Much confusion about the income taxation of co-ops exists.
Example Misconception:“These super co-ops (22 largest) virtually escape all Federal income taxation. Unless the Co-op tax and antitrust laws are revised, we will continue to see in ever increasing numbers, co-op expansion into the competitive market place. The tax-base erosion by the tax-favored, if not the tax-free, co-ops is particularly upsetting in light of the present economy. Now is the time for Congress to end the co-op use of tax-free capital for competitive marketplace intrusion.”
(Nat’l Tax Equality Assoc., 1980)
![Page 3: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/3.jpg)
Much confusion about the income taxation of co-ops exists.
Reality:
These 22 co-ops paid $68 million Federal income taxes in 1980. Their tax rate as a percent of earnings was nearly 15 percent which was larger than for many large non co-op firms in the U.S.
![Page 4: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/4.jpg)
How a Co-op’s Earnings are Taxed Depends Primarily on:
1. The source of those earnings.a. Patronageb. Nonpatronage*
2. The distribution (or use) of those earnings.a. Retained earnings (unallocated)b. Allocated patronage refunds
1. Qualified2. Nonqualified
c. Stock dividends*
3. The co-op’s ‘tax status’ (521 or non-521) for items denoted with a * above.
![Page 5: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/5.jpg)
Taxation laws determine how co-op earnings are taxed.
Example situation:
Recently, Sioux Honey Assn. had net earnings of $10 million and yet paid income taxes of only $30,000. Why didn’t the co-op pay more taxes?
![Page 6: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/6.jpg)
Taxation laws determine how patronage refunds are taxed.
Example situation:
• Suppose you receive a $1,000 patronage refund of which $200 is cash and $800 is noncash.
• How much of this do you include in your taxable income for the year?
• How much of this can the co-op deduct from its taxable income for the year?
![Page 7: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/7.jpg)
Overview of Co-op Earnings for Tax Purposes
Total Co-op Earnings
Nonpatronage Earnings* Patronage Earnings
Retained Allocated Allocated Retained
Qualified Refunds/Distribution
Nonqualified Refunds/Distribution Dividends*
Cash Noncash
![Page 8: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/8.jpg)
Some Basics of Co-op Income Taxation
1. Co-ops are NOT automatically exempt from income taxes.
2. Patronage refunds are generally subject to ‘single’ taxation.
3. To be taxed like a co-op, firms can organize and operate as a co-op.
![Page 9: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/9.jpg)
Qualified Patronage Refunds1. Must be based on patronizing the co-op2. Must be a pre-existing obligation to pay3. Must be allocated correctly:
a. Within 8.5 months after the end of the co-op’s fiscal year
b. At least 20% in cash(noncash = written notice of allocation including
stocks and certificates)
c. Noncash portion must be:1. Redeemable in cash within 90 days OR2. Distributed to patrons with their ‘consent’
![Page 10: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/10.jpg)
Obtaining Patron Consent
1. Letter from Patron
2. Bylaw Consent
3. Cash a Qualified Check
![Page 11: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/11.jpg)
Taxation of QUALIFIED Patronage Refunds
Year of Issuance
Member: Pays tax on entire amount
including cash and noncash
amounts
Co-op: Claims entire amount as a
deduction from its taxable income
![Page 12: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/12.jpg)
Taxation of QUALIFIED Patronage Refunds
Year of Redemption
Member: No additional tax is due (already
paid income tax on it)
Co-op: Cannot claim as a deduction
(did previously when issued)
![Page 13: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/13.jpg)
• $1000 Qualified Pat. Ref., TAXATION– => $200 Cash, $800 Non cash
• Year of ISSUANCE– Member reports $1000 taxable income– Co-op deducts $1000 from taxable income
• Year of REDEMPTION– Co-op pays and member receives $800 cash– Co-op and member do NOT report this on tax
return
![Page 14: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/14.jpg)
Taxation of NONQUALIFIED Patronage Refunds
Year of Issuance
Member: Pays tax on cash portion only
Co-op: Deducts cash portion from its
taxable income; pays tax on
noncash portion
![Page 15: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/15.jpg)
Taxation of NONQUALIFIED Patronage Refunds
Year of Redemption
(of previous noncash allocation)
Member: Pays tax on cash received
Co-op: Deducts amount paid out in cash
from taxable income for either the
year of redemption (co-op has its
choice; the co-op should opt for
the greatest tax savings) or year of issuance.
![Page 16: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/16.jpg)
• $1000 Non Qualified Pat. Ref., TAXATION
• Year of ISSUANCE– Member reports $0 taxable income– Co-op reports $1000 taxable income
• Year of REDEMPTION– Member reports $1000 taxable income– Co-op claims $1000 as tax-deductible
expense
![Page 17: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/17.jpg)
Which is Best – Qualified or Non Qualified?
• Look at after-tax net cash flows:– Year of issuance member– + Year of issuance co-op– + Year of redemption member– + Year of redemption co-op
_____________________________
= Total Net Cash Flow
(May want to discount redemption yr NCF’s)
![Page 18: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/18.jpg)
Which is Best – Qualified or Unqualified?
The co-op should choose that form which results in the combined taxes of both the co-op and patrons being minimized. Nonqualified allocations would likely accomplish this better if patron income tax rates are currently relatively high (expected to be lower in the future) and if co-op income tax rates are currently relatively low (expected to be higher in the future). Qualified allocations would likely be preferred if the opposite were true.
![Page 19: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/19.jpg)
Taxation of Unallocated or Retained Co-op Earnings
Co-op: Pays tax on entire amount
retained (just as other businesses
do)
Member: No tax impact
![Page 20: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/20.jpg)
• Taxation of per-unit capital retains = same as patronage refunds except there is no 20% cash refund requirement
![Page 21: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/21.jpg)
Key 521 Co-op Requirements(about 25% of top 100 Ag Co-ops)
1. At least 85% co-op stock owned by ‘active’ members.
2. At least 50% of total business volume and 85% of supply business volume must be done with ‘members’.
3. Must treat members and nonmembers alike regarding pricing and patronage refunds.
![Page 22: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/22.jpg)
521 vs Non-521 Co-op Taxation
• Nonpatronage Earnings Received– 521: Taxable to patrons if allocated– Non-521: Taxable to co-op
• Stock Dividends Paid– 521: Taxable to patrons only– Non-521: Taxable to patrons and co-op
![Page 23: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/23.jpg)
Nonpatronage Earnings
= Incidental income that is not directly
related to the marketing, purchasing,
or service activities of a co-op
Examples:1. Rent
2. Interest Income
3. Capital Gains
4. Sales to Fed. Government
5. Dividends Received
![Page 24: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/24.jpg)
Factors that Would Favor 521 Tax Status
1. Substantial Stock Dividends
2. Very Little Nonmember Patronage
3. Substantial Nonpatronage Income
4. High Co-op Tax Bracket
5. Exemption from Federal Security Registration
![Page 25: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/25.jpg)
Alternatives for Allocating Losses
1. To unallocated reserves.
2. To current patrons in proportion to patronage (or equity)
a. Reduce deferred equity
b. Collect cash (deduct from proceeds: bill directly)
3. Carry forward
![Page 26: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/26.jpg)
Local Cooperative Losses May:
1. Reduce a member’s equity
2. Increase a member’s after-tax net cash flow if allocated to the member
![Page 27: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/27.jpg)
• Regional co-op losses, when allocated to a local, are ‘paper’ expenses for the local that lower the local’s net earnings (taxable income)
![Page 28: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/28.jpg)
Net Cash Flow Impacts of Regional Co-op Losses
Allocated Not Allocated
Local Co-op (100% qualified)
Local savings 20,000 20,000
- Loss allocation 10,000 0
Net Income 10,000 20,000
Cash Pat. Refs. 2,000 4,000
Net Cash Flow 18,000 16,000
Patron (10% Share)
Oth. Taxable Inc. 30,000 30,000
Cash pat. Ref. 200 400
Noncash Pat. Ref. 800 1,600
Taxes (t = .3) 9,300 9,600
Net Cash Flow 20,900 20,800
![Page 29: Unit VI. Income Taxation of Co-ops. Much confusion about the income taxation of co-ops exists. Example Misconception: “These super co-ops (22 largest)](https://reader034.vdocuments.site/reader034/viewer/2022051619/56649e015503460f94aeb520/html5/thumbnails/29.jpg)
Regional Cooperative Losses May Drastically Reduce a Local’s:
1. Equity
2. Earnings
Yet increase a local’s:
1. Net Cash Flow