Sub-Chapter T Cooperatives

Internal Revenue Code:  Subchapter T

The current authority for cooperative taxation is Subchapter T of the Internal Revenue Code‐ it applies to any corporation operating on a cooperative basis. Under Subchapter T, all cooperative income must be included in gross income when the cooperative is determining taxable income.

Patronage refund allocations and per unit retain certificates, however, are deductible from the cooperative’s taxable income if certain requirements have been met, allowing for single tax treatment of a co-op’s patronage sourced earnings.

Patronage refunds, the distributions of a cooperative’s net earnings to patrons of the co-op on the basis of their use of the co-op, can be distributed in three ways: cash, equity investments (sometimes called capital credits, equity certificates, or other names), or property. Patronage refunds that are paid as equity investments are evidenced by a written notice of the allocation to the co-op patron. The value of the written notice of allocation can be deducted from the cooperative’s taxable income, as long as the allocations are appropriately qualified according to the Internal Revenue Code.

Per unit retains, deductions from the proceeds of sales based on the value or quantity of products marketed for a patron, can be distributed back to members as cash, equity, or debt. Per unit retains that are considered equity investments are evidenced by a per unit retain certificate. The value of the certificate can be deducted from the cooperative’s taxable income, as long as the allocations are qualified according to the Internal Revenue Code.

To qualify a written notice of allocation of a patronage refund, the cooperative must:

  • Pay at least 20% of the patron’s patronage refund in money or qualified check, and either,
  • Give the patron the option to redeem the notice within 90 days for money, or
  • Ensure that the patron has consented to include the value of the notice in their taxable income.

To qualify a per unit retain certificate, the cooperative must:

  • Ensure consent by the patron to include the value of the certificate in their taxable income.

Qualified allocations or certificates are deductible from the income of the co-op, but must be included in the taxable income of the patron receiving the allocation in the year they are received. When the equity certificates are redeemed at a later date, no additional income taxes are due by the member.

Nonqualified allocations or certificates are not deductible from the taxable income of the co-op, so the co-op pays tax on the income. If the co-op later redeems the nonqualified allocations, the value of the allocation is taxable income for the member and the co-op can receive a tax credit for the amount.

Unallocated profits are taxed at the cooperative level at the corporate tax rate. Profits paid as dividends on equity are taxed both at the cooperative level and the stockholder level.

 

References

“Cooperatives in Wisconsin: The Power of Cooperative Action.” University of Wisconsin Center for Cooperatives. Retrieved from http://www.uwcc.wisc.edu/pubs/Publications/CoopsInWI_2014_web.pdf

Frederick, D. (1995). “Tax Treatment of Cooperatives.” (U.S. Department of Agriculture Rural Business and Cooperative Development Service Cooperative Information Report 23). Washington, D.C.: U.S. Government Printing Office.

Frederick, D. (2005). “Income Tax Treatment of Cooperatives: Distributions, Retains, Redemptions, and Patrons’ Taxation.” U.S. Department of Agriculture Rural Business-Cooperative Programs Cooperative Information Report 44, Part 3. Washington, D.C.: U.S. Government Printing Office.

Frederick, D. (2005). “Income Tax Treatment of Cooperatives: Patronage Refunds and Other Income Issues” U.S. Department of Agriculture Rural Development Cooperative Information Report 44, Part 2. Washington, D.C.: U.S. Government Printing Office.

Frederick, D. & Ingalsbe, G. (1993). “What are Patronage Refunds?”, U.S. Department of Agriculture Agricultural Cooperative Service Cooperative Information Report 9. Washington, D.C.: U.S. Government Printing Office.

Hahn, D. (n.d.). “Taxes- Cooperatives and the Internal Revenue Service.” Columbus, OH. The Ohio State University.

Smith, S. & Chesnick, D. (2013). “Income Tax Treatment of Cooperatives: Background” (U.S. Department of Agriculture Rural Development Cooperative Information Report 44, Part 1). Washington, D.C.: U.S. Government Printing Office.

Williamson, L. (1987). “The Farmer’s Cooperative Yardstick: Should Your Cooperative be “Exempt” or “Non-Exempt.” University of Kentucky College of Agriculture Cooperative Extension Service Publication No. AEC-53. Retrieved from http://www.uky.edu/Ag/AgriculturalEconomics/pubs/aec53.pdf