Some Tax Reform Related Discussions for the Board

Phil Kenkel

Bill Fitzwater Cooperative Chair

As I have been discussing in the last few newsletters, the Tax Cuts and Jobs Act of 2017 has created some new issues for cooperative boards.  Cooperative principles do not mention tax deductions or tax effects.  However, those issues are clearly now part of our cooperative business model.  The cooperative board’s challenge has expanded to a three dimensional balance of cash flow, patronage and tax deductions.  Before your board meets with the auditor to work through all of the possible choices, it is helpful for the board to have some philosophic discussions.

The first discussion should focus on how the board views the Section 199A deduction.   Do you want to keep most members equivalent or more than equivalent with producers marketing through non- cooperative firms?  Alternatively, do you view the deduction solely in terms of what the cooperative can use with member pass through being purely a residual?  Your board should also consider whether the tax effect could discourage any producers from marketing with the cooperative. Conversely, you should consider whether some members can’t even use the pass through deduction.  The Section 199A effects are specific to each producer so your board should probably consider the central mass of the membership.

The second discussion should focus on profit distribution and retention.  If your board was presented with two new alternatives, one which channeled more funds to the members and one which created more investment in the cooperative, which one would interest you most?  Before you dig in to the choices of retaining and distributing profits, it useful to have a big picture discussion.  Given the change it corporate tax rates I would encourage you to consider retaining funds as nonqualified equity, but that is a detail you can discuss with the auditor.

The final discussion should consider your philosophy toward unallocated equity.  I know that sounds like a tactic, but there is a philosophical dimension.  Allocated equity increases the member’s sense of ownership and their return from the cooperative.  Unallocated equity creates permanent capital and reduces the need for some future board of directors to manage equity. High levels of unallocated equity creates the temptation for members to liquidate the cooperative. There has been a general trend for agricultural cooperatives to increase the ratio of unallocated equity.  In many cases, that was not due to a conscience decision but rather the byproduct of tax management decisions.  If your board has never thought about the cooperative’s equity structure, and set goals for the minimum and maximum ratio of unallocated you want on your balance sheet, I would encourage you to have that discussion.

Tax reform has reduced the corporate tax rate and reshuffled some tax deductions.  That makes it a logical time to re-examine profit distribution and tax management strategies.  The best way not to be overwhelmed with the choices is to have the high-level discussion about what you want to accomplish.