Author: Chris Peterson, Michigan State University, peters17@msu.edu
The mechanics of returning net income to members is rather straightforward. On an annual basis, net income is divided by patronage revenue. Assume that this number is 10 percent for a particular cooperative for a particular year. Each member receives a patronage refund equal to 10 percent of the value of the patronage business that the member did with the cooperative. If the member did $10,000 in patronage, the refund is $1,000 ($10,000 x 10%).
As long as a cooperative allocates all its patronage net income to patronage refunds, it does not have to pay federal corporate income taxes. Cooperatives enjoy what is termed “single taxation.” In contrast, standard corporations are exposed to “double taxation” in regard to dividends. Corporate income is taxed at federal corporate rates, and then any dividends declared (after corporate taxes) to investors are taxed again as income to the investors. Corporate dividends are thus taxed at two levels—the corporate level and the investor level. Patronage refunds are only taxed once. The cooperative has no federal income tax liability as long as it allocates all its net income to members on a patronage basis and returns at least 20 percent of the refund in cash. An additional requirement is that the members individually must pay federal income tax on the total refund and not just on the cash portion. (Note: In the section on raising equity, we will talk about why cooperatives do not return all patronage refunds in cash. For now, it is simply necessary to know that a qualified patronage refund for federal income tax purposes must be paid 20 percent in cash to members.)
Several issues can complicate this otherwise simple computation. First, many cooperatives do business other than patronage business. Sometimes they deal with non-members, for example, or have a standard corporation subsidiary doing non-patronage business. Non-patronage business is subject to federal income taxes in certain instances. It depends on the tax status of the cooperative (exempt or non-exempt) and how non-members are treated in the refund allocation process.