Taxation of Cooperatives and Their Patrons, written by Carla Neeley Freitag, Esq., analyzes the federal income tax treatment of cooperatives and patrons. A cooperative is a business format in which patrons of the cooperative join together to transact business collectively. The principle underlying the federal income tax treatment of cooperatives and their patrons is that earnings derived by a cooperative from transacting business with and for its patrons are taxed once at the patron level rather than twice at both the cooperative and patron levels.
This Portfolio provides a brief history of the federal income tax treatment of cooperatives, summarizes the rules of Subchapter T, and examines the basic characteristics that identify a cooperative subject to Subchapter T.
It also discusses the requirements for exemption as a farmers' cooperative. Exempt farmers' cooperatives must limit their activities to marketing the agricultural products of members or other producers and purchasing equipment and supplies for sale to members and other persons. Both marketing and purchasing functions must be conducted on a nonprofit basis. The transaction of business between an exempt farmers' cooperative and nonmembers is limited, and all patrons, whether members or nonmembers, must be treated equally.
Taxation of Cooperatives and Their Patrons defines the unique terms employed by Subchapter T and examines the tax treatment of cooperatives and patrons, respectively.
Finally, this Portfolio discusses the application of the alternative minimum tax in the context of cooperatives. The returns required to be filed by exempt and nonexempt cooperatives are identified as well.
Taxation of Cooperatives and Their Patrons allows you to benefit from:
This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.
Detailed Analysis
I. Introduction
A. Cooperatives in General
B. Background
1. Early Statutory and Case Law
2. Subchapter T
3. Role of Legislative History in Construing Subchapter T
C. Introduction to Subchapter T
1. Rationale for Tax Treatment of Cooperatives
2. Exempt and Nonexempt Cooperatives
3. Treatment of Distributions
4. Scope of Portfolio
II. Applicability of Subchapter T
A. Overview
B. Operating “On a Cooperative Basis”
1. Characteristics of Cooperatives
a. In General
(1) Three Cooperative Principles
(2) Puget Sound Plywood, Inc. v. Comr.
(3) Trump Village, Section 3, Inc. v. Comr.
b. Subordination of Capital
c. Democratic Control
(1) Voting Rights Required
(a) One Vote Per Member
(b) No Democratic Control
(c) Relationship Between Subordination of Capital and Democratic Control
(2) Approved Voting Formats
(a) Basic Voting Format
(b) Voting by Proxy
(c) Voting by Written Ballot in Lieu of a Meeting
d. Proportionate Allocation of Profits
(1) Allocation Based on Patronage
(2) Investment vs. Patronage
(3) Examples of Proportionate Allocations
(4) Requirement Strictly Construed
2. Business with Nonmembers
a. Exempt Cooperatives
(1) Quantity of Nonmember Business
(2) Equal Treatment for Nonmembers
b. Nonexempt Cooperatives
(2) Equal Treatment Not Required
3. Substance Over Form
a. Labels Not Controlling
b. Statute of Organization Not Controlling
c. Member Participation
d. Mississippi Valley Portland Cement Co. v. U.S.
C. Cooperatives Subject to Subchapter T
1. Exempt Farmers' Cooperatives
a. Requirements for Exemption
(1) Farmers,' Fruit growers,' or Like Organizations
(a) Patrons Must Produce Agricultural Products
(b) Examples of Eligible Cooperatives
(c) Examples of Noneligible Cooperatives
(2) Organized and Operated on a Cooperative Basis
(3) Permitted Purposes
(a) Marketing Function
(i) Marketing and Incidental Activities
(A) In General
(B) Eugene Fruit Growers Ass'n v. Comr.
(C) IRS Authorities
(ii) Producers
(A) Producer Defined
(B) Farmers Coop. Creamery Ass'n v. U.S.
(iii) Permissible Purchases from Nonproducers
(A) Necessary Sideline Purchases
(B) Ingredient Purchases
(C) Emergency Purchases
(D) “Look Through” to Corporation's Membership
(E) Purchases from Producers' Agent
(b) Purchasing Function
(4) Nonprofit Requirement and Equal Treatment of Patrons
(a) Nonprofit Requirement
(b) Equal Treatment of Patrons
(i) All Patrons Treated Equally
(ii) Transactions with Nonpatrons
(iii) Crediting Patronage Dividends of Nonmembers
(iv) Separate Divisions or Functions
b. Additional Issues
(1) Capital Stock
(a) Fixed Dividend Rate
(i) Value of the Consideration
(ii) Etter Grain Co., Inc. v. U.S.
(b) Limited Ownership by Nonproducers
(i) Substantially All Requirement
(A) No Set Percentage
(B) Federated Cooperatives
(ii) Qualified Producers
(A) Quantity of Patronage
(B) Timing of Patronage
(C) Who Is a Shareholder?
(D) Bylaw Provisions for Termination of Shareholder Status
(2) Reserve
(a) Investment of Reserve
(b) Interrelationship Between Reserve and Exemption Requirements
(3) Transactions with Nonmembers
(a) Express Limitations
(b) Federated Cooperatives
(4) Business for the United States
(5) Subsidiaries
c. Procedural Matters
(1) Grant and Revocation of Exemption
(2) Declaratory Judgment
2. Nonexempt Cooperatives
a. Corporation Requirement
b. Not Limited to Agricultural Pursuits
D. Cooperatives Not Subject to Cooperative Rules
III. Terminology
A. Patron
1. Transaction of Business on a Cooperative Basis
2. Mississippi Valley Portland Cement Co. v. U.S.
3. Mississippi Chemical Corp. v. Comr.
4. MVP Cement and Mississippi Chemical Compared
B. Patronage Dividend
1. Business Done with or for Patrons
a. Test for Distinguishing Patronage Income from Nonpatronage Income
(1) Regs. 1.1382-3(c)(2)
(2) Rev. Rul. 69-576
(3) Farmland Indus., Inc. v. Comr.
(4) Directly-Related Test Prevails
b. Application of Test to Specific Receipts
(1) Marketing of Products
(2) Sales to Members
(3) Interest
(a) Introduction
(b) IRS Rulings
(c) St. Louis Bank for Cooperatives v. U.S.
(d) Twin County Grocers, Inc. v. U.S.
(e) Cotter & Co. v. U.S.
(f) Illinois Grain Corp. v. Comr.
(g) Washington-Oregon Shippers Cooperative, Inc. v. Comr.
(h) Certified Grocers of California, Ltd. v. Comr.
(i) Dundee Citrus Growers Ass'n v. Comr.
(j) CF Industries, Inc. v. Comr.
(k) Analysis of Authorities
(4) Dividends
(5) Rent
(a) In General
(b) Cotter & Co. v. U.S.
(c) Illinois Grain Corp. v. Comr.
(6) Gain from the Sale of Stock
(a) Farmland Industries, Inc. v. Comr.
(b) IRS Acquiesces in Farmland Industries
(7) Gain from the Sale of 1231 Property
(b) Farmland Industries, Inc. v. Comr.
(c) Sale of Assets upon Liquidation
(8) Payments from Commodity Credit Corporation
(9) Distributions from Pass-Through Entities
(a) Use of Pass-Through Entities by Cooperatives
(b) Distributions from Cooperatives
(c) Distributions from Limited Liability Companies
(d) Distributions from Limited Partnerships
c. Allocation
2. Determination By Reference to Net Earnings from Patronage Sources
a. “By Reference To”
b. Net Earnings
(1) In General
(a) Regs. 1.1388-1(a)(1)
(b) Allocation of Expenses
(2) Treatment of Dividends on Capital Stock
(a) Distributions in Tax Years Beginning On or Before October 22, 2004
(i) Reduction of Net Earnings
(ii) Background
(iii) Mississippi Chemical Corp. v. U.S.
(iv) Authorities Upholding Dividend Allocation Rule
(b) Distributions in Tax Years Beginning After October 22, 2004
(3) Optional Netting of Patronage Gains and Losses
(a) Use of Allocation Units
(b) Notice Requirements
(4) Netting After 381(a) Transactions
3. Allocation Based on Quantity or Value of Business
a. Allocation Methods
b. Multiple Cooperative Activities
4. Equitable Allocation Among Patrons
5. Preexisting Obligation of Payment
C. Written Notice of Allocation
1. Written Notice of Allocation Defined
a. Adequate Disclosure Required
b. Form of Issuance
2. Qualified Written Notice of Allocation
a. Requirements
b. Right of Redemption
c. Consent of Patron
(1) Consent in Writing
(a) Requirements for Consent
(i) Requirements of 1388 and Regulations
(ii) Independent Coop. Milk Producers Ass'n, Inc. v. Comr.
(b) Application and Revocation
(c) Special Rule for Pooling Arrangements
(2) Consent by Membership
(ii) Cases Applying Consent by Membership
(3) Consent by Qualified Check
(b) Land O'Lakes, Inc. v. U.S.
d. 20% Cash Requirement
(1) Purpose of Requirement
(2) Use of Cash Payment to Offset Patrons' Liabilities to Cooperative
(3) Payment to Patrons' Assignees
(4) Constructive Receipt Not Sufficient
3. Nonqualified Written Notice of Allocation
D. Qualified Check
E. Per-Unit Retain Certificate
1. Per-Unit Retain Certificate Defined
2. Qualified Per-Unit Retain Certificate
3. Nonqualified Per-Unit Retain Certificate
IV. Tax Treatment of Cooperatives
Introductory Material
A. Taxable Income - In General
1. Gross Income
b. Cooperative as Nontaxable Intermediary or Trustee
(1) Seven-Up Co. v. Comr.
(2) Affiliated Foods, Inc. v. Comr.
(3) Park Place, Inc. v. Comr.
(4) Concord Village, Inc. v. Comr.
2. Deductions (Other than 1382 Deductions)
b. Net Operating Losses
(1) Deduction of Net Operating Losses
(b) Segregation of Patronage and Nonpatronage Gains and Losses
(2) Section 277 Not Applicable
(3) Impact of 199 Deduction
c. Deduction for Cooperative's Income from U.S. Production Activities
(1) Section 199 in General
(2) Terminology of 199 Pertaining to Cooperatives
(a) Specified Agricultural or Horticultural Cooperative
(b) Qualified Payment
3. Calculation of Cooperative's Deduction
4. Pass-Through to Patrons
5. Examples
6. Credits
B. Deduction of Distributions from Patronage Sourced Income by All Cooperatives
1. Exclusion vs. Deduction
2. Categories of Deductible Distributions
a. Patronage Dividends
(1) Requirements for Deduction
(2) Redemption of Qualified Written Notices of Allocation
(a) No Consequences
(b) Redemption at Less Than Fair Market Value
b. Redemption of Nonqualified Notices of Allocation
c. Per-Unit Retain Allocations
(2) Redemption of Qualified Per-Unit Retain Certificates
d. Redemption of Nonqualified Per-Unit Retain Certificates
3. Payment Issues
a. Payment Period
b. What Constitutes Payment?
c. Payment by Successor Organization
4. When Patronage Occurs
a. Significance of When Patronage Occurs
b. Marketing and Patronage in Pooling Arrangements
c. Earnings Received After Patronage Occurred
C. Deduction of Distributions from Nonpatronage Sourced Income
1. Dividends on Capital Stock
2. Distributions on a Patronage Basis from Nonpatronage Sourced Income
D. Computation of Tax Where Cooperative Redeems Nonqualified Written Notices of Allocation or Nonqualified Per-Unit Retain Certificates
1. Seven-Step Approach
2. Examples
E. Nondeductible Distributions
F. Reduction for 199 Deduction Passed Through to Patrons
V. Tax Treatment of Patrons
A. General Rule
1. Distributions Includible in Gross Income in Year of Receipt
2. Receipts Includible upon Redemption
B. Exclusions from Gross Income
C. Miscellaneous
1. Self-Employment Tax
2. Deduction of Taxes, Interest, and Business Depreciation by Tenant-Stockholders
3. Deduction for Cooperative's Income from U.S. Production Activities
VI. Alternative Minimum Tax Treatment
VII. Returns and Compliance
Working Papers
Table of Worksheets
Worksheet 1 Written Notices of Allocation
Worksheet 2 Written Notices of Allocation: Consent Bylaws and Form of Written Consent
Worksheet 3 Exempt Farmers’ Cooperatives and Nonexempt Cooperatives Quick Reference
Bibliography
OFFICIAL
Treasury Rulings:
Cases:
UNOFFICIAL
Periodcals
1998
1999
2002
2005
2006