Authors: Greg McKee, North Dakota State University, gregory.mckee@ndsu.edu, and Donald Frederick,
Rural Business-Cooperative Service, USDA
Cooperatives may delay the pass-through of the tax obligation from the cooperative to the patron without jeopardizing single tax treatment of those moneys.
Any patronage-based allocation not meeting the requirements of the Code to be “qualified,” has “nonqualified” status. When a nonqualified allocation is made, the cooperative pays corporate income taxes on the funds retained. The patron has no tax obligation on these funds in the year of allocation.
Tax Treatment of Cooperative and Patron Qualified Retained Equity
If the cooperative in the earlier example issues its patronage refunds as nonqualified written notices of allocation, it would have taxable income of $100, the amount of the margin. The patron’s taxable income would have been $600, the payment for the crop.
At some later time, when nonqualified retained equity is redeemed, the cooperative receives a tax benefit based on the tax paid at the time of allocation. The patron is taxed on the funds received. In the example, the cooperative would deduct the $100 paid to the patron (or receive a credit under certain circumstances). The patron would report the $100 as income in the year the cash payment was received.
Thus the single tax treatment of cooperatives doing business with or for members is complete and consistent with that accorded other single-tax entities. Income is ultimately taxed once, at the level of the owner-user of the business.
Nonqualified allocations have particular appeal to cooperatives with member-patrons in high marginal tax brackets. If the cooperative uses qualified allocations, it must make substantial cash payouts or high income patrons may suffer a negative cash flow on the margins they generate. This occurs when the total tax owed on the allocation (Federal and state) exceeds the amount of cash paid out as part of the distribution.
By using nonqualified allocations, no tax is due from patrons until the allocation is redeemed. Also, there is no 20-percent cash payout rule for nonqualified allocations.