4.44.1  IRC section 521 Exempt Farmers’ Cooperatives

4.44.1.1  (01-01-2002)
Overview

  1. Tax exempt farmers' cooperatives, as described in IRC section 521, have been in Employee Plans/Exempt Organizations (EP/EO) since its inception in the mid 1970s. Originally, all nonexempt cooperatives were in the Examination Division. In 1981, the IRS administratively moved a subsegment of nonexempt cooperatives, those with farmers as members, from the Examination Division to the EP/EO Division. The Examination Division continued to have responsibility for all other nonexempt cooperatives described in Subchapter T of the Internal Revenue Code.

  2. As part of the IRS Modernization initiatives, EP/EO (which became the Tax Exempt/Government Entities {TE/GE} operating division) proposed that farmers' cooperatives be handled by the Small Business/Self-Employed (SB/SE) and Large and Mid-Size Business (LMSB) operating divisions. An agreement was reached that this customer would be housed in LMSB (specifically Retail, Food, Pharmaceutical & Healthcare (RFPH), and examination coverage, if needed, for filings below $10 million assets be contracted out to SB/SE.

  3. Farmers' cooperatives (Form 990-C filers) are covered by Subchapter T of the Internal Revenue Code. There is no legal tax distinction between nonexempt farmers' cooperatives and other nonexempt cooperatives (Form 1120 filers) under Subchapter T of the Code.

  4. Guidance is provided for examiners of farmers' cooperatives under IRC section 521. As part of its background, a discussion is provided on:

    1. Why farmers' cooperatives were formed.

    2. The historical background of IRC section 521.

  5. IRM 4.76.26 provides a discussion of auditing techniques suitable for use in the examination of cooperatives.

4.44.1.1.1  (01-01-2002)
Why Farmers’ Cooperatives Are Formed

  1. The exemption of farmers’ cooperatives is based upon an economic situation peculiar to farmers. A farmer sells his products in a producers’ (wholesale) market and makes his purchases in a retail market. Conceivably, a farmer might invest more money in his crop in the form of seed and fertilizer than he is able to obtain for it when it is harvested.

  2. Farmers attempted to correct this condition by forming associations to:

    1. Market their products at a price nearer the retail price and to make their purchases at wholesale rather than retail;

    2. Pay the operational expenses; and

    3. Remit earnings to patrons or member-producers, as patronage dividends or stock dividends, respectively.

  3. Generally, Subchapter T provides for the deductibility of the following payments, which are unavailable to other Subchapter C associations:

    1. Certain patronage dividends;

    2. Certain per unit retain allocations; and

    3. In the case of IRC section 521 farmers' cooperatives, certain nonpatronage income, such as interest and dividends on capital stock.

  4. Subchapter T also provides for the tax treatment of certain income received by the patrons from cooperatives.

  5. The examination of cooperatives has the following objectives:

    1. To determine whether the organization is either a taxable or exempt farmers' cooperative;

    2. To determine the exempt status of a farmers' cooperative claiming exemption under IRC section 521;

    3. To determine whether the organization is operating on a cooperative basis within the scope of IRC sections 1381–1388; and

    4. To determine the correct amount of tax.

4.44.1.1.2  (01-01-2002)
Historical Background

  1. The statute exempting farmers’ cooperatives from tax has remained unchanged from 1926 to the present with one exception. In 1934, Congress added the precursor to IRC section 521(b)(5), concerning business done with the United States. See IRM 4.44.1.1.1.3, which discusses the statutory background of cooperatives, for further information.

4.44.1.1.3  (01-01-2002)
Statutory Background

  1. In 1951, Congress passed legislation which, when complemented by Treasury rulings, was thought to ensure that earnings of cooperatives, to the extent they reflected business activity, would be currently taxable either to the cooperatives or to the patrons. However, certain court decisions (Long Poultry Farms v. Commissioner, 249 F. 2d 726 (4th Cir. 1957); Commissioner v. B. A. Carpenter, 219 F. 2d 635 (5th Cir. 1955)) held that noncash allocations of patronage dividends generally were not taxable to the patron although the allocations were deductible by the cooperatives. Congress determined that further clarification was necessary.

  2. In 1962, Congress added subchapter T to the Code (consisting of IRC sections 1381 through 1388) to address the defects of prior law. It clarifies, in general, that:

    1. A cooperative may deduct, as patronage dividends, amounts allocated in cash or scrip; and

    2. Its patrons are currently taxed on such dividends.

  3. IRC section 522 relating to tax on farmers' cooperatives has been repealed. However, this section continues to apply with respect to patronage dividends paid before December 31, 1962 (or after this date with respect to patronage occurring during taxable years beginning before January 1, 1963, and with respect to redemption of patronage dividends after that date if the scrip involved was actually issued with respect to an earlier year).

4.44.1.1.4  (01-01-2002)
Cooperative Technical Advisor

  1. A full time Cooperative Technical Advisor serves as a sounding board for unusual techniques and as a means of disseminating interesting findings to other examiners.

  2. Team managers and examiners are encouraged to remain in frequent contact with the Cooperative Technical Advisor.

  3. Contact the Cooperative Technical Advisor as needed for workshops and preaudit analysis of assigned cooperative cases. The following web site provides contact information: http://lmsb.irs.gov/hq/pftg/techguide/retail_pharm/farm_coop/index.htm. Resources available through the Cooperative Technical Advisor include:

    • Digest of Rulings on Farmers' Cooperatives

    • List of Cooperative Industry websites

    • Sample IDR's

    • Audit Techniques

    • Case Histories

4.44.1.1.5  (01-01-2002)
Application for Taxpayer Assistance Order

  1. If, during a taxpayer contact, it appears there may be a hardship situation, complete Form 911, Application for Taxpayer Assistance Order, and refer the taxpayer to the Taxpayer Advocate Service (TAS). See IRM Part 13 or IRM 21.1.3.17 for more information.

4.44.1.2  (01-01-2002)
Meaning of Certain Terms

  1. Relevant terms, which are defined below, include:

    • Farmers', fruit growers', and the like

    • Organized and operated on a cooperative basis

    • Member

    • Producer

    • Miscellaneous terms

4.44.1.2.1  (01-01-2002)
Farmers', Fruit Growers', and Like Associations

  1. The only organizations eligible for exemption under IRC section 521 are farmers', fruit growers', or like associations.

    1. The regulations limit this exemption to cooperative organizations whose members are engaged in farming, fruit growing, or similar occupations. See Treas. Reg. 1.521-1(d).

    2. The terms "farmers" and "fruit growers" limit "like associations" to those associations which market agricultural products or purchase supplies and equipment for persons engaged in producing agricultural products, i.e., agricultural producers. See Sunset Scavenger Company, Inc. v. Commissioner, 84 F.2d 453 (9th Cir. 1936). For a discussion on permissible members, see IRM 4.44.1.1.2.3.

  2. A "farm" is a facility used primarily for raising agricultural products. The term includes livestock, dairy, poultry, fruit, and truck farms. It also includes plantations, ranches, nurseries, ranges, greenhouses, and orchards of fruit, nut, or sugar maple trees. A facility in which fish are raised for sale is a "farm" See Revenue Ruling 64-246. However, ordinary commercial fishermen are not "farmers" , per Revenue Ruling 55-611, because they do not raise their product.

  3. Associations which have been denied exemption because they were not "like" farmers' or fruit growers' associations include:

    1. An association of garbage collectors, Sunset Scavenger Company, Inc. v. Commissioner, 84 F.2d 453 (9th Cir. 1936);

    2. An association of advertising agents,National Outdoor Advertising Bureau Inc. v. Helvering, 89 F.2nd 878 (2d Cir. 1937);

    3. A corporation that markets products of lumber producing companies, Revenue Ruling 73-570;

    4. A federated cooperative that converts pulpwood into newsprint, Revenue Ruling 84-81.

  4. State law does not control in determining whether a farmers' cooperative is described in IRC section 521, according to Munro L. Lyeth v. Hoey, 305 U.S. 188 (1938).

4.44.1.2.2  (01-01-2002)
Organized and Operated on a Cooperative Basis

  1. IRC section 521(b) requires that a farmers' cooperative association be "organized and operated on a cooperative basis" . Generally, an organization is operated on a cooperative basis within the meaning of IRC section 521 if it allocates net profits to patrons on the basis of the business done with or for such patrons.

    1. Treas. Reg. 1.521-(a)(1) clarifies that such an association must keep permanent records of the business done both with members and nonmembers, in order to show its cooperative nature, and to establish compliance with the Internal Revenue Code, which requires that the proceeds of sales, less necessary expenses, be turned back to all producers on the basis of either the quantity or the value of the products furnished by them.

    2. The records need not be unduly detailed. However, they must, at a minimum, be a set of permanent records which show that the association was operating during the taxable year on a cooperative basis in the distribution of patronage dividends to all producers.

  2. Whether an organization is organized and operated on a cooperative basis cannot be determined solely by a review of its articles of incorporation.

    • An association that is confined to cooperative selling for the benefit of its patrons, but which has additional charter powers, may nevertheless be exempt. See Revenue Ruling 68-496.

    • An association’s articles need not provide for equal dividends between members and nonmembers, if its business is solely with members. See Eugene Fruit Growers Ass’n v. Commissioner, 37 B.T.A. 993 (1938).

4.44.1.2.3  (01-01-2002)
Member

  1. A member is any person (including an individual, corporation or partnership), ordinarily a producer shareholder, who shares in the profits of a cooperative and is entitled to participate in the management of such cooperative, according to Treas. Reg. 1.521-1(a)(3). See Producers Livestock Marketing Ass’n of Salt Lake City v. Commissioner, 45 B.T.A. 325 (1941) regarding participation in management.

4.44.1.2.4  (01-01-2002)
Producer

  1. In general, a person is a producer if, as an owner or tenant, he/she is engaged in the trade or business of farming, (e.g., if he/she bears some risks of production, and cultivates, operates, or manages a farm for gain or profit).

  2. Thus, a person who receives a rental (either cash or in kind) which is based upon farm production, is a producer. Generally, a person who receives a fixed rental or other fixed compensation (without reference to production) is not a producer. Six examples, five drawn from Revenue Ruling 67-422, are provided at IRM 4.44.1.1.2.4.1. See also Dr. P. Phillips Cooperative v. Commissioner, 17 T.C. 1002 (1951) for a discussion on risk-taking.

4.44.1.2.4.1  (01-01-2002)
Examples

  1. A stockbroker owns pasture land and rents it to a dairy farmer, who grazes his cattle thereon. The dairy farmer pays the stockbroker a periodic fixed rental fee. The stockbroker’s rental activity does not qualify him as a producer.

  2. A land owner leases his land to a tenant farmer for a specified number of years. The lease obligates the farmer to farm the land and pay the land owner a rental based on a certain fixed percentage of the farm crops produced. The farmer has the option of paying the land owner in farm crops or their equivalent value in cash. The land owner and the farmer qualify as producers.

  3. A practicing physician also operates a for-profit dairy farm through a manager. The manager is paid a fixed salary and has authority to make most managerial decisions for his principal. The physician qualifies as a producer; the manager does not.

  4. The facts are the same as in (3) except that the manager and the physician are partners in the farm’s operation and the manager’s pay is solely a percentage of the farm’s net profit. Both the manager and the physician qualify as producers.

  5. A corporation manufactures fertilizer, and maintains land devoted to raising farm products for sale at a profit. The corporation qualifies as a producer.

  6. A feed dealer furnishes poultry to a grower, who agrees to raise such poultry and turn it over to the dealer for marketing through a cooperative. If they share the risk of production, they may be producers, per Revenue Ruling 58-483.

4.44.1.2.5  (01-01-2002)
Definition of "Capital Stock"

  1. Treas. Reg. 1.1382-3(b) defines the term "capital stock," to include common stock (whether voting or nonvoting), preferred stock, or any other form of capital represented by capital retain certificates, revolving fund certificates, letters of advice, or other evidence of a proprietary interest in a cooperative. See Treas. Reg. 1.1382-2(b).

4.44.1.2.6  (01-01-2002)
Miscellaneous Definitions

  1. The definition of the terms "patron" and "patronage dividend" are covered in IRM 4.44.1.9.2.

4.44.1.3  (01-01-2002)
Permissible Activities

  1. An exempt farmers' cooperative must be engaged in:

    1. Marketing the products of members and other producers; or

    2. Purchasing supplies and equipment for use by members and other persons.

  2. An exempt farmers' cooperative may conduct limited business with, or for, the United States.

4.44.1.3.1  (01-01-2002)
Marketing By IRC Section 521 Cooperative

  1. The marketing activity of an IRC section 521 cooperative is limited to marketing the products of members or other producers. Marketing activities include the operation of marketplaces (Revenue Ruling 67-430), and canneries (Revenue Ruling 77-384). The marketing process includes any activity necessary to marketing, including processing, packing, crating, shipping, storing, and manufacturing.

  2. Cooperative dairy companies engaged in collecting and disposing of milk or its by-products (butter, cheese, etc.) are exempt from tax. See Treas. Reg. 1.521-1(a)(1). Such products may be affected by:

    1. Processing, (see Revenue Ruling 77-384, where the association manufactured cloth from the producer’s baled cotton, and marketed the cloth); or

    2. Comingling with products purchased from outside sources.

  3. Orchard maintenance and harvesting do not in themselves constitute "marketing." See Revenue Ruling 66-108.

4.44.1.3.2  (01-01-2002)
Purchasing By IRC Section 521 Cooperative

  1. The purchasing activity of an IRC section 521 cooperative is limited to purchasing supplies and equipment for the use of members or other persons.

  2. The term "supplies and equipment" as used in IRC section 521 includes groceries and all other goods and merchandise used by farmers in the operation and maintenance of a farm or farmer's household, according to Treas. Reg. 1.521. This includes grain and feed (Farmers Union Co-operative Ass’n v. Commissioner, 44 B.T.A. 34 (1941)), and grazing land (Revenue Ruling 67-42), if used as cattle feed.

    • The supplies and equipment must be for the use of the ultimate purchasers in their activities as producers, except supplies and equipment sold to nonmember/nonproducers within the 15-percent statutory limitation. See Revenue Ruling 67-223. See IRM 4.44.1.1.4.1.1 concerning the 15-percent limitation applicable to purchasing cooperatives.

  3. A purchasing cooperative may obtain raw materials that it converts into manufactured or refined products, and sell such products to patrons as "supplies or equipment." Thus, a purchasing cooperative may manufacture crates and fertilizers (see S.M. 2288, III-2 C.B. 233 (1924)), and refine petroleum products (Revenue Ruling 54-12).

4.44.1.3.3  (01-01-2002)
Business with U.S. Government

  1. RC section 521(b)(5) provides that business done with, or for, the United States or any of its agencies shall be disregarded in determining the right to exemption. Thus, in determining the percentage requirements specified in IRC section 521(b)(4), relating to transactions with nonmembers and nonproducers, the amount of business done with the United States shall be disregarded. However, a cooperative endangers its right to IRC section 521 status if the amount of business done with, or for, the United States is so extensive that the association would no longer be characterized as a farmers’ cooperative.

  2. Profits from activities performed for federal agencies need not be returned as patronage dividends to the government but may be distributed among the patrons.

4.44.1.4  (01-01-2002)
Patronage of Purchasing and Marketing Cooperatives

  1. Consider the IRC section 521 status of:

    1. Purchasing cooperatives with regard to the 50-percent nonmember limit and the 15-percent nonmember/nonproducer limit; and

    2. Marketing cooperatives with regard to the 50-percent nonmember limit and the total proscription on nonproducer items.

4.44.1.4.1  (01-01-2002)
Purchasing Cooperatives

  1. If nonmember purchases exceed 50-percent of the value of all purchases, or if nonproducer-nonmembers make purchases exceeding 15-percent of the value of all purchases, an exemption from taxation is not allowed.

    Example:

    A purchasing cooperative purchases $320,000 worth of goods for its member-producers and $280,000 worth for nonmembers. Of the $280,000 goods obtained for nonmembers, $95,000 went to nonproducers. The association met the "50-percent nonmember/business test," but purchases for nonmember/nonproducers is over 15-percent of the value of all its purchases; thus, an exemption is not allowable.

4.44.1.4.1.1  (01-01-2002)
15-percent Limitation

  1. Revenue Ruling 54-12 provided a sales of by-products exception to an otherwise strict construction of the 15-percent limitation. Revenue Ruling 69-417 prospectively modified Revenue Ruling 54-12. Thus, after August 4, 1969, the sale of by-products may not be disregarded in computing the 15-percent limitation.

    Example:

    A purchasing cooperative, operating an oil refinery, delivered petroleum products to other refineries. The other refineries, in turn, delivered a like quantity of the same products to the distributing agency of the cooperative, from their stocks located at points convenient to its farmer-patrons. The exchanges were made to effect a savings in transportation costs. The value of these exchanges may be disregarded in determining the 15-percent limitation of IRC section 521(b)(4). See Revenue Ruling 54-12. However, a product processed by a purchasing cooperative and exchanged for an unlike product processed by a nonmember/nonproducer will be considered to have been purchased by the cooperative for the nonmember/nonproducer for purposes of the IRC section 521(b)(4) 15-percent limitation.

  2. However, with respect to the purchased item, the nonmember/nonproducer is a patron entitled to patronage dividends, and the products delivered to the other patrons of the cooperative by the nonmember/nonproducer will be considered a sale to them by the cooperative, and exemption is not jeopardized.. See Revenue Ruling 67-346.

4.44.1.4.2  (01-01-2002)
Marketing Cooperatives

  1. In determining a qualifying exemption:

    If... Then...
    The value of items marketed for nonmembers exceeds the value of products marketed for members Exemption is denied.
    Any item is marketed for a nonproducer (or for a nonproducer/nonmember) Exemption is denied.

  2. In determining to what extent a marketing cooperative is dealing with nonproducers, only those products grown or otherwise produced by producers will be considered as the products of its members. However, the marketing of certain nonmember products is ignored. These include:

    • Emergency purchases

    • Sideline purchases

    • Ingredient purchases

  3. "Emergency" purchases generally involve the unanticipated inability of a marketing cooperative to satisfy contract commitments solely with products furnished by producer/patrons. If purchases are made from nonproducers (dealers, dairies, etc.) under such circumstances, with the intent merely to meet orders rather than to earn a profit, exemption will be unaffected. (See Revenue Ruling 69-222 and Producers’ Produce Company v. Crooks, 2 F. Supp. 969 (W.D. Mo. 1932).)

    Example:

    It would be permissible for a fruit marketing cooperative to make purchases of fruit to satisfy contract commitments if producers were unable to meet demand because their orchards were damaged by a freeze. However, if an association contracts to market more goods than it expects to be able to supply from its usual producers, the purchase of nonproducer goods to fulfill its contracts would not be an "emergency" purchase.

  4. A marketing cooperative may, to a limited extent, sell nonproducer items at retail, if the purpose is to facilitate the normal sale of producer items and the sales are incidental, (a "sideline" ) to the marketing of producer items. See Revenue Procedure 67-37. For example, a dairy cooperative may find it difficult to market the milk products of its patrons at retail, unless it also markets nonproducer fruit juice and eggs as a sideline.

  5. A safeharbor rule exists for de minimis sales. Sales of 5-percent (or less) of total retail sales are considered to be de minimis. Sales exceeding this safeharbor must be decided on the basis of all the facts and circumstances.

  6. A marketing association may purchase ingredients from nonproducers if the purchases are required to convert unfinished producer items into finished products. For example, a marketing association might produce ice cream from the milk products of its members. In processing the ice cream, it is necessary to add sugar and flavoring. Any purchases of sugar and flavoring for this purpose are "ingredient" purchases. It is important that the purchase of nonproducer ingredients be limited to those necessary to put the agricultural product in a marketable condition. See Eugene Fruit Growers Ass’n v. Commissioner, 37 B.T.A. 993,1000 (1938).

4.44.1.5  (01-01-2002)
Dividends

  1. Generally, an association may have two types of dividends that must be reviewed to determine whether the association qualifies as an IRC section 521 exempt farmers’ cooperative.

    1. Patronage dividends, which must be distributed to all patrons without discrimination as to membership/nonmembership status; and

    2. Stock dividends, which may be distributed in a fashion favoring members, but such dividends and their source capital stock are subject to other important restrictions.

4.44.1.5.1  (01-01-2002)
Nondiscrimination in Distribution of Patronage Dividends

  1. Generally, IRC section 521 discrimination is discrimination in patronage dividends distribution which occurs when the distribution is biased toward member patrons. Often such discrimination is effected by mere practice or by-laws provisions.

  2. The prohibition on member/nonmember discrimination protects even that nonmember producer who deals with the cooperative through a member who functions as that producer’s agent. The member must submit evidence to the cooperative that the nonmember received the sales proceeds of the marketing, less necessary marketing expenses. See Revenue Ruling 55-496, but see also Revenue Ruling 76-338, concerning emergency sales for fixed prices. This nondiscrimination rule does not invalidate the IRC section 521(b)(4) 50-percent limitation. See IRM 4.44.1.1.4.1.

  3. Consider the following discriminatory practices:

    1. Marketing cooperative’s payment of higher prices for member products than those paid to nonmembers.

    2. Profits on capital items which inure ultimately to members exclusively. See Fertile Co-operative Dairy Ass’n v. Huston, 119 F.2d 274 (8th Cir. 1941).

    3. An association distributes, as patron refunds, only a part of the net profits. See Farmers Cooperative Grain and Live Stock Ass’n v. Commissioner, 46 B.T.A. 1276 (1942).

4.44.1.5.1.1  (01-01-2002)
Nondiscriminatory Distributions

  1. Discrimination in patronage dividend distribution does not affect IRC section 521 qualifications if such discrimination is not rooted in a member/nonmember distinction. Thus, an association does not endanger its IRC section 521 tax exemption merely because:

    1. It issues only whole-dollar patronage dividends, or retains the cents (i.e., change), per Revenue Ruling 55-141.

    2. In an effort to reduce the paperwork necessary to comply with the IRC section 1388(c) 20-percent requirements, the association pays patronage (or nonpatronage) dividends below $10 in cash or qualified check, and patronage dividends in excess of $10 by qualified written notice of allocation. See Revenue Ruling 66-152 and Treas. Reg. 1.521-1(f).

    3. The association makes payments solely in nonqualified written notices of allocation to those patrons who do not consent to have a qualified written notice of allocation included in their gross income. See IRC section 1388(c) and Treas. Reg. 1.521-1(f) concerning the effect of consent.

4.44.1.5.1.2  (01-01-2002)
Exceptions

  1. The following are not to be construed as discrimination between patrons.

    1. The cooperative may discriminate against the United States. See IRC section 521(b)(5).

    2. An association, instead of paying patronage dividends to nonmember/producers in cash, keeps permanent records from which the proportionate shares of the patronage dividends due to nonmember/producers can be determined and such shares are made applicable toward the purchase price of a share of stock or a membership in the association. See Treas. Reg. 1.521-1(a)(1).

    3. A cooperative withholds an amount due a nonmember/patron, not exceeding the membership fee, for operational expenses (see Revenue Ruling 69-52) . The cooperative is merely requiring those who benefit from the cooperative’s facilities to share its operational costs.

    4. An association pays a smaller amount of interest or dividends on nonqualified written notices of allocation and nonqualified per-unit retain certificates held by nonconsenting and nonagreeing persons, respectively, than it pays on qualified written notices of allocation and qualified per-unit retain certificates, provided that the amount of interest or dividend reduction is reasonable in relation to the fact that the association receives no tax benefit with respect to such nonqualified written notices of allocation and nonqualified per-unit retain certificates until redeemed. However, such an association will be denied exemption if, in any other respect, it treats nonconsenting and nonagreeing patrons differently from patrons who have consented or who have agreed, either with regard to their original payment or allocation or with regard to the redemption of written notices of allocation or per-unit retain certificates. See Treas. Reg. 1.521-1(f).

    5. An exempt farmers’ cooperative that makes emergency purchases and purchases of sideline products for fixed prices from a nonmember/nonproducer is not required to pay patronage dividends to the nonmember/nonproducer. See Revenue Ruling 76-388. See also IRM 4.44.1.1.4.2 concerning marketing cooperatives.

4.44.1.5.2  (01-01-2002)
Capital Stock and Stock Dividends

  1. Many farmers' cooperatives are organized as membership associations without capital stock, and IRC section 521(b)(2) provides that exemption will not be denied a cooperative because it has capital stock. There are, however, important limitations on the dividend rate, the extent to which capital stock ownership may be dispersed, and the type of stock that may be issued.

  2. The dividend rate on all stock must not exceed the legal rate of interest in the State of incorporation or 8-percent per annum, whichever is greater, on the value of the consideration for which the stock was issued (not par value). The prohibition is strictly construed. Thus, the issuance of a nontaxable stock dividend to shareholders does not increase the "value of the consideration for which the stock was issued" (Revenue Ruling 68-169), unless additional consideration is paid to the cooperative.

  3. IRC section 521 requires that substantially all voting stock or stock with dissolution rights be held by producer/patrons. Revenue Ruling 73-248 provides that "substantially all" is considered to be at least 85-percent. (But see Revenue Ruling 67-204. Association issued shares to patrons, but were not successful when they requested such patrons to redeem their shares when they became nonproducer patrons. Consequently, numerous shareholders were nonproducers. Exemption was denied.)

    1. Any ownership of voting stock by other than producer/patrons must be satisfactorily explained in the association’s application for exemption. The association will be required to show that the ownership of its voting stock has been restricted as far as possible to such producers.

    2. If, by statutory requirements, all officers of an association must be shareholders, the ownership of a share of stock by a nonproducer to qualify him/her as an officer will not destroy the association’s exemption.

  4. Likewise, if the association is unable, because of a constitutional restriction or prohibition or other reason beyond the control of the association, to purchase or retire the voting stock of such nonproducer, the fact that under such circumstances a small amount of the outstanding voting stock is owned by shareholders who are no longer producers will not destroy the exemption. (See Treas. Reg. 1.521-1(a)(2).) However, the general rule is that substantially all stock must be held by producers that are currently patronizing the cooperative. See Co-operative Grain and Supply Co. v. Commissioner, 407 F.2d 1158 (8th Cir. 1969).

  5. An organization will not be denied exemption merely because a substantial part of its voting stock is held by its membership committee as trustees for the members. Capital stock so held is deemed owned by patron/producers. See Revenue Ruling 56-21.

  6. Outside capitalization may be accomplished by issuing nonvoting common stock, nonvoting preferred stock, bonds or other evidences of indebtedness.

    1. The restriction upon capital stock ownership does not apply to nonvoting stock, provided the holders of such securities do not participate in profits upon dissolution or otherwise beyond the regular fixed dividends or interest payments. See IRC section 521(b)(2) and Treas. Reg. 1.5211(a)(2).

    2. Of course, the dividend rate limit applies to all classes of stock. See IRM 4.44.1.1.5.2(2) above, concerning the dividend rate.

  7. For further guidance concerning organizations with capital stock, see text in Law Enforcement Manual VII.

4.44.1.6  (01-01-2002)
Accounting Issues

  1. There are certain accounting issues that should be considered.

    • How the cooperative offsets its losses

    • How an IRC section 521 cooperative may properly offset nonpatronage income

    • What the organization characterizes as "necessary marketing expenses"

    • Accumulation of reserves

4.44.1.6.1  (01-01-2002)
Offsetting Losses Across Separate Functions

  1. Under IRC section 521(b)(6) and IRC section 1388(j)(1), to the extent losses from one function may be attributable to business done with patrons, losses from that function may be netted against patronage earnings from another function, at the option of the cooperative. These provisions were enacted in 1986, but are effective retroactively; i.e., for all taxable years beginning after December 31, 1962. These two provisions apply to the netting of patronage losses against patronage gains. Nonexempt cooperatives cannot use patronage losses to offset nonpatronage earnings. See Farm Service Cooperative v. Commissioner, 619 F.2d 718 (8th Cir. 1980).

  2. Farmers’ cooperatives frequently divide their marketing (or purchasing) function into logical subdivisions called "departments," which handle different product lines. Subdivisions of departments are called "branches." The gross receipts of the departments and branches are accounted for separately.

    1. Costs which are reasonably identifiable are charged to the division to which related;

    2. Costs which are not identifiable are allocated to each division in a generally accepted cost accounting method; and

    3. The net income of each division so computed is then allocated to the patrons of that particular division in proportion to the amount of business that those patrons have transacted with the division. Compare with IRM 4.44.1.1.6.2 concerning nonpatronage income.

4.44.1.6.2  (01-01-2002)
Nonpatronage Income

  1. A cooperative (whether exempt or nonexempt) may have nonpatronage income, i.e., earnings not directly related to the marketing or purchasing functions, which can be distributed as a patronage dividend to patrons of an exempt cooperative. Examples of nonpatronage income include:

    • The lease of premises

    • Interest earned

    • The sale or exchange of capital assets

    • Business done with the United States or any of its agencies

  2. The existence of nonpatronage income does not raise an exemption issue, but there is an accounting issue. If a cooperative association "departmentalizes," it may allocate nonpatronage income to the department or departments to which the nonpatronage income relates. See Juniata Farmers Cooperative Ass’n v. Commissioner, 43 T.C. 836 (1965), acq., 1966-1 C.B. 2, and Revenue Ruling 67-128. Compare with IRM 4.44.1.1.6.1, concerning separate functions.

    Note:

    In no event, may patronage losses offset nonpatronage income of another department.

4.44.1.6.3  (01-01-2002)
Necessary Marketing Expenses and Purchasing Expenses

  1. Necessary marketing expenses that are considered in arriving at net earnings would include all expenses made to prepare the product for its final sale, from the time it is turned over to the association by the producer. Expenses of grading, packing, crating, processing, canning, drying, freezing, evaporating, and shipping qualify as marketing expenses. See IRM 4.44.1.1.3.1.

  2. Purchasing expenses include the cost of transforming raw materials into the product desired by the cooperative’s patrons. Salaries, depreciation, rentals, etc., are ordinary and necessary in the operation of a cooperative association.

  3. If marketing expenses are unnecessary, they reduce proceeds that are turned back to the members and other producers, and the association’s exemption is jeopardized. Payment of life insurance premiums might be one such "unnecessary" expense. See Revenue Ruling 55-558. See also Revenue Ruling 76-233, where a cotton marketing cooperative acquires a wool processing company.

4.44.1.6.4  (01-01-2002)
Accumulation and Maintenance of Reserves

  1. IRC section 521(b)(3) permits exempt cooperatives to accumulate certain reserves for two specified purposes, without loss of exemption:

    1. To satisfy a state statutory duty, not mere legal privilege, to maintain a reserve, or

    2. For any necessary purpose such as to provide for the erection of buildings and facilities required in business, for the purchase and installation of machinery and equipment, or to retire indebtedness incurred for such purposes. See Treas. Reg. 1.521-1(a)(3).

  2. Reserves for depreciation and bad debts are not considered in either the first or the second classification of permissible reserve structure. These reserves are set up as part of actual operating costs and are not a segregation of surplus.

  3. To come within the second class, the reserve must be reasonable and for a necessary purpose.

    Example:

    A reserve for overpayments to members was allowed, where under State law, the amounts set up belonged to the members rather than the corporation. See San Joaquin Valley Poultry Producers’ Ass’n v. Commissioner, 136 F.2d 382 (9th Cir. 1943).

  4. A permissible reserve must either be allocated or apportioned among the patrons on the basis of the business transacted by them. See Fertile Co-operative Dairy Ass’n v. Huston, 119 F.2d 274 (8th Cir. 1941). The allocation may be in the form of either nonqualified or qualified written notices of allocation, as those terms are used in IRC section 1382(b). However, such reserves, if not presently allocated, must still be apportioned among the patrons on the books of the cooperative.

4.44.1.7  (01-01-2002)
Applications and Returns

  1. In order to establish its exemption, every organization claiming exemption as a farmers' cooperative is required to file Form 1028. Forms 1028, executed in accordance with the instructions, are filed with the Cincinnati Service Center.

  2. Associations exempt under IRC section 521 must file income tax returns, Form 990-C, on or before the 15th day of the ninth month following the close of the taxable year.

4.44.1.8  (01-01-2002)
Digests of Published Rulings and Procedures

  1. There are a number of significant rulings, revenue procedures and court cases concerning IRC section 521, that are digested below.

4.44.1.8.1  (01-01-2002)
Revenue Rulings

  1. Lumbering—A federated cooperative marketing newsprint, and its member cooperatives supplying pulpwood cut from timber grown by the cooperative’s patron members, do not qualify as farmers' cooperatives described in IRC section 521. Lumbering is not considered an activity encompassed by the phrase, "farmers', fruit growers', or like associations" per Revenue Ruling 84-81.

  2. Like association; lumber products—A corporation engaged in selling the products of independent lumber companies is not entitled to exemption from taxation as a "like association" within the meaning of section 231(11) of the Revenue Act of 1918. Neither is the corporation in question organized and operating in the manner contemplated by the statute. The selling company does not collect the sale price from the purchasers and turn it back to the members, but the sales price is paid directly by the purchaser to the producing company. I.T. 1312, I-1 C.B. 263.

  3. Fifty-percent nonmember test—The M Company is engaged in the manufacture and sale of dairy and other farm products and the purchase of general farm supplies. At times, it becomes necessary for this corporation to purchase supplies from other cooperative creameries so that contracts with patrons may be fulfilled. The above corporation does not purchase produce from other than members, except in cases of emergency when the amounts supplied by members are not sufficient to fill outstanding orders. A sufficient amount for such purpose is purchased from other cooperative creameries, and because its other activities are not such as to deprive it of the exemption, the M Company is an exempt corporation under the provisions of section 231(11) of the Revenue Act of 1921. I.T. 1598, II-1 C.B. 159.

  4. Centralized purchasing and sale of products—A corporation formed by several farmers' clubs and unions for the purpose of coordinating in one central agency the purchase of supplies and the sale of the products of the members of such organizations, which deals with its member clubs and unions only and distributes its income by prorating its profits back to such members on the basis of their purchases and sales through the corporation, is entitled to exemption from taxation under the provisions of section 231(11) of the Revenue Act of 1921. I.T. 2000, III-1 C.B. 290.

  5. Purchasing agency—The taxpayer, a stock corporation, was organized for the purpose of purchasing and furnishing supplies to the various local citrus growers' associations in the State of Y which are connected with the central selling agent of a large number of citrus fruit growers in Y. The company furnishes to its members, exclusively, at actual cost plus necessary expenses, the supplies necessary in the production and marketing of citrus fruits. The company clearly acts as a purchasing agent within the meaning of section 231(11) of the Revenue Act of 1921, although in the process of furnishing crates and fertilizer at the lowest possible price, it buys the raw materials rather than the completed articles and expends a certain amount of labor upon them before turning over the completed crates and fertilizer to its members. S.M. 2288, 111-2 C.B. 233.

  6. Sales agency for other cooperatives— The M Exchange is a nonprofit cooperative corporation, without capital stock, organized and operated for the purpose of acting as the central sales agent and representative of a substantial part of the citrus growers of the State of Y. The exchange operates so that the proceeds from the sale of the fruit of each grower are returned to him/her, less his/her proportionate part of the necessary expenses. The exchange is entitled to exemption from tax under section 231(11) of the Revenue Acts of 1918 and 1921. S.M. 2286, III-2 C.B. 236.

  7. Nonmember sales; taxable income—The M Company, which acts as a purchasing agent for members, supplies and sells to nonmembers at a profit, such profit being returned to members by reduction of costs or rebates, is not exempt from taxation as a farmers', fruit growers', or like association. S.M. 2595, III-2 C.B. 238.

  8. Like association; building materials—Corporation engaged in marketing building materials on a cooperative basis is not organized and operated for purposes of marketing products of farmers, fruit growers, or others engaged in like occupations under section 103(12) of the Revenue Act of 1928, G.C.M. 8619, X-1 C.B. 150.

  9. Processing of agricultural products—A cooperative association was organized primarily to process its member's agricultural products into alcohol. The alcohol was sold to a company for use in producing gasohol. Cooperatives may change the basic form of their member's products and consequently the cooperative qualifies as a farmers' cooperative described in IRC section 521. Revenue Ruling 81-96.

  10. Name requirement—Farmers' cooperative marketing and purchasing associations, whose bylaws set forth a definite preexisting obligation of the association to make distribution to patrons of a portion of the net profits as patronage dividends, may have such dividends excluded from income for federal income tax purposes regardless of whether the corporate name contains the word "cooperative." Revenue Ruling 55-26.

  11. Patronage dividends; retention of small amounts; certificates and dividends not delivered—The retention by farmers' cooperatives of each patronage dividend less than one dollar and similar retentions of the cents payable in excess of whole dollar amounts do not constitute inequitable treatment of all patrons to an extent which would jeopardize the exempt status of the cooperative. The mailing of checks or stock representing patronage dividends, by a farmers' cooperative is payment, and deduction is allowed even though the postal authorities are unable to make delivery and the cooperative holds the instrument subject to the claim of the rightful owner. Revenue Ruling 55-141.

  12. Fifty-percent nonmember test—A cooperative marketing association otherwise qualifying for exemption under IRC section 521 will not be denied such exemption if it markets members' products furnished by nonmember producers, where the member is legally bound to turn back to such producers the proceeds of the sale of their products, less necessary marketing expenses, and to furnish the association with evidence that such obligation has been met. The value of the products marketed for such nonmembers must not exceed the value of the products marketed for the members. Revenue Ruling 55-496.

  13. Life insurance on members—A farmer’s cooperative marketing association which purchases life insurance policies on the lives of its members does not meet the requirements for exemption under IRC section 521, since it would not be turning back to its members and other producers the proceeds of the sales of their products less the necessary marketing expenses. Revenue Ruling 55-558.

  14. Allocation of income on patronage basis—The allocation of income of a farmers' cooperative marketing association resulting from the handling and storage of grain of the Commodity Credit Corporation during the fiscal year ended May 31, 1954, which is distributed on a patronage basis to persons who have done business with the association during any or all of the fiscal years 1949 through 1954, will not affect the exempt status to which the association is otherwise entitled under section 101(12)(A) of the 1939 Code. Revenue Ruling 55-591.

  15. Purchases of supplies and equipment for fishermen—An association which purchases supplies and equipment for its members who are fishermen is not a farmers' purchasing association within the meaning of IRC section 521(b)(1) and, therefore, is not exempt from federal income tax under that section. Revenue Ruling 55-611.

  16. Stock held in trust by membership committee—A farmers' cooperative marketing and purchasing association otherwise exempt from taxation under IRC section 521 will not be denied such exemption if a substantial part of its voting capital stock is held in trust by its membership committee for members of the association who are the beneficial owners thereof. Capital stock so held qualifies as stock "owned by producers who market their products or purchase their supplies and equipment through the association" within the intent of IRC section 521. Revenue Ruling 56-21.

  17. Changing inventory method—A cooperative changed from LIFO to FIFO for inventory purposes, which required a positive adjustment to income under IRC section 481(a). It was held that even though the adjustment relates to business done with the cooperative’s patrons in prior years, it results in patronage earnings that are includible in the cooperative’s gross income in the year of the adjustment for purposes of IRC section 1382(f). Revenue Ruling 79-45.

  18. Share agreement—Where feed dealers contract with growers who agree to properly feed and care for poultry which is turned over to the dealers for marketing through a farmers' cooperative association, both the feed dealer and the grower qualify as producers with respect to the interest of each in the poultry marketed. Under such circumstances, the exempt status of a farmers' cooperative association will not be adversely affected. Revenue Ruling 58-483.

  19. Commodity Credit Corporation income—When, as part of the price support program, money is loaned to a farmer-producer on his warehouse receipt for grain stored in a nonexempt cooperative, storage charges paid to the cooperative by the Commodity Credit Corporation, for the period before the patron’s default on his loan payment, are income allocable to members as patronage dividends and excludable from the cooperative’s income. The charges paid following default constitute income not derived from patronage. In either case, allocations to the patrons are taxable income to the patron. Revenue Ruling 59-107.

  20. Integrated business unit; marketing and storage— The marketing activity of a nonexempt farmers' cooperative may be combined with its storage activity so that the two aspects of the business are treated as a unit. However, where a cooperative distributes profits only to member patrons, the exclusion under IRC section 522 will be limited to that portion of the dividend attributable to member business. Revenue Ruling 63-58.

  21. Marketing fish—An association organized and operated on a cooperative basis for the purpose of marketing "farm-raised fish" is considered an organization composed of producers of farm products. Accordingly, the organization is held to be entitled to exemption from federal income tax as a farmers', fruit growers', or like association within the meaning of IRC section 521. Revenue Ruling 64-246.

  22. Marketing or purchasing for or with U.S.—An exempt farmers' cooperative will not jeopardize its status if it does business of a marketing or purchasing nature for or with the U.S. or an agency thereof so long as it otherwise continues to engage in marketing or purchasing activities for its patrons. Revenue Ruling 65-5.

  23. Harvesting crops—A farmers' cooperative association whose only activities consist of caring for and maintaining its patrons' orchards and harvesting their crops, does not qualify for exemption as an association described in IRC section 521. Revenue Ruling 66-108.

  24. Distribution in full; small amounts—A farmers' cooperative may, without jeopardizing its exempt status, make cash payments in full where the patronage dividends or nonpatronage distribution is $10 or less, and may pay $10 or 20-percent of the total dividend, whichever is greater, on all dividends in excess of $10. Revenue Ruling 66-152.

  25. Emergency purchases—The exempt status of a farmers' cooperative marketing association will not be adversely affected by emergency purchases from nonproducers to fulfill outstanding orders based on normal crop expectations. Revenue Ruling 69-222.

  26. Allocation of nonpatronage dividends and losses—A farmers' cooperative association may, without jeopardizing its exempt status, allocate nonpatronage income and losses to the department to which the income and losses relate, provided that the allocation is not discriminatory among patrons similarly situated. Revenue Ruling 67-128.

  27. Fifty-percent nonmember test—A cooperative association which markets products purchased by members which exceed in value those grown or otherwise produced by members for whose accounts such products are marketed, violates the limitation placed on business done with "nonmembers" under IRC section 521. Furthermore, by marketing products of nonmembers as those of its members, the association does not meet the statutory requirement that proceeds of the sale of products, less necessary operating expenses, be returned to producers on the basis of the quantity or value of products furnished by them. Revenue Ruling 67-152.

  28. Stock issued to nonproducers—A farmers' cooperative purchasing association issues shares of voting common stock to patrons without regard to the status of such patrons as producers or nonproducers, requesting that patrons who are not producers of agricultural products return their shares for redemption. As a result of this practice and the failure of many nonproducers to comply with the association’s request, numerous nonproducers have become shareholders. Held, the association is not complying with the requirements of IRC section 521(b) (2) and the regulations thereunder which require that ownership of capital stock be restricted to actual producers as far as possible. Accordingly, the association is not exempt from federal income tax under IRC section 521. Revenue Ruling 67-204.

  29. Fifteen-percent nonmember/nonproducer test—For purposes of the applicable 15-percent test provided in IRC section 521(b)(4), supplies purchased by a member of a farmer’s cooperative for use in his/her nonfarming business will be treated as purchases made for persons who are neither members nor producers. Revenue Ruling 67-223.

  30. Records and allocation requirements—A farmers' cooperative marketing and purchasing association does not maintain records of the amount of business done with its marketing patrons separate from those pertaining to the amounts of business done with the purchasing patrons. The association apportions its expenses between the marketing and purchasing departments solely on the basis of gross sales of each department, and it allocates patronage dividends only to patrons of its purchasing department. This association is not exempt under IRC section 521. Revenue Ruling 67-253.

  31. Fifteen-percent nonmember/nonproducer test—A product processed by a farmers' purchasing cooperative exempt from federal income tax under IRC section 521 and exchanged for an unlike product processed by a nonmember/nonproducer will be considered to have been purchased by the cooperative for the nonmember in determining whether the value of purchases made for persons who are neither members nor producers exceeds 15-percent of the value of all purchases as provided in IRC section 521(b)(4). The nonmember/nonproducer will be considered a patron of the cooperative, and the amount of product delivered to the other patrons of the cooperative by the nonmember/nonproducer will be considered a sale to them by the cooperative. Revenue Ruling 54-12, distinguished. Revenue Ruling 67-346.

  32. Producer—The Service sets forth circumstances under which a person may be considered a producer for purposes of IRC section 521. Revenue Ruling 67-422.

  33. Grazing land control—A cooperative association which acquires the beneficial use of land and apportions it among its members for grazing their livestock may be exempt from federal income tax under IRC section 521. Revenue Ruling 67-429.

  34. Marketing Association—A cooperative association formed for the purpose of furnishing its members a place to market their farm products may be exempt from federal income tax under IRC section 521. Revenue Ruling 67-430.

  35. Artificial breeding—A cooperative association that owns sire cattle and produces and processes semen for use in the artificial breeding of its members’ livestock may qualify for exemption under IRC section 521. Revenue Ruling 68-76.

  36. Nontaxable stock dividend—The issuance by a farmers' cooperative association of a nontaxable stock dividend to its shareholders does not increase the "value of the consideration for which the stock was issued" for the purpose of the dividend limitation provided under IRC section 521(b)(2). Revenue Ruling 68-169.

  37. Broad business powers—A farmers' cooperative association may be exempt under IRC section 521 even though its articles of incorporation include broad business powers so long as the activities of the association meet the IRC section 521 requirements. Revenue Ruling 68-496.

  38. Patronage dividends; reasonable amounts withheld from nonmembers—A farmers' cooperative will continue to qualify for exemption under IRC section 521 where reasonable amounts of patronage dividends are withheld from nonmembers to meet the cost of its operation. Revenue Ruling 69-52.

  39. Emergency purchases from nonproducers—The exempt status of a farmers' cooperative marketing association will not be adversely affected by emergency purchases of farm products from nonproducers to fulfill outstanding orders based on normal crop expectations. However, such purchases must be caused by unforeseen circumstances to qualify as emergency purchases. Revenue Ruling 69-222.

  40. Sale of byproducts to nonproducers—The sale of byproducts to nonproducers by an exempt farmers' cooperative purchasing association may not, after August 4, 1969, be disregarded in computing the fifteen-percent limitation of IRC section 521(b)(4) . Revenue Ruling 54-12, modified by Revenue Ruling 69-417.

  41. Profits; participation beyond dividends payable on stock—A farmers' cooperative association does not qualify for exemption under IRC section 521 where stockholders are permitted to participate in the profits of the association beyond the amount of dividends payable on their stock. Revenue Ruling 69-431.

  42. Subsidiary corporation—Farmers' cooperative associations will lose their exempt status under IRC section 521 if subsidiary corporations established to handle nonmember/nonproducer business fail to pay patronage dividends to nonmember patrons or violate the fifteen-percent limitation on purchases. Revenue Ruling 69-575.

  43. Patrons of member associations; "Looking through" —Several examples illustrate the application of the principle of "looking through" to ultimate patrons of member associations in determining whether a federated farmers' cooperative meets the requirements for exemption under IRC section 521. Revenue Ruling 69-651.

  44. Leases; marketing facilities—A farmers' cooperative association is not exempt under IRC section 521 where it leases its marketing facilities and relinquishes its authority to negotiate the prices paid to its members for their products. Revenue Ruling 71-100.

  45. Patron’s status as producer; stockholder of corporation—A stockholder of a corporation does not qualify as a producer solely because the corporation engaged in farming so qualifies; however, he/she may qualify if, independent of his/her stock ownership, he/she meets the requirements of a producer. Revenue Ruling 67-422, amplified by Revenue Ruling 72-589.

  46. Nonmember dividends deposited in suspense reserve—A livestock marketing cooperative prohibited under the Packers and Stockyards Act of 1921 from distributing patronage dividends to nonmembers does not qualify for exemption by depositing those dividends in a patronage refund suspense reserve. Revenue Ruling 73-59.

  47. Noncash allocation; deceased member’s estate—A written notice of allocation made by an exempt farmers' cooperative to the estate of a deceased member, who during his lifetime had filed a consent pursuant to IRC section 1388, for business conducted with the cooperative prior to his/her death is deductible by the cooperative as a patronage dividend. The estate is required to include the noncash allocation in gross income. For any additional cooperative written notices of allocation with respect to the decedent, the estate would be required to follow the normal membership procedure. Revenue Ruling 73-93.

  48. Nonexempt supply association for nonmembers—A nonexempt supply association formed by the officers and directors of an exempt farmers' cooperative is, under the circumstances, considered a subsidiary of the cooperative, and the cooperative will lose its exempt status if the association’s purchases for nonmember/nonproducers exceed fifteen-percent of the combined purchases of both organizations. Revenue Ruling 73-148.

  49. Subsidiary DISC—A tax exempt farmers' cooperative association may own a DISC for purposes of marketing its member's produce abroad without affecting its exempt status; ownership of the DISC by the cooperative, as the sole shareholder, will not prevent qualification as a DISC. Revenue Ruling 73-247.

  50. Stock ownership; "substantially all" test—The "substantially all" test is satisfied if at least 85-percent of the total shares of capital stock of a farmers' cooperative (other than nonvoting preferred stock for which the owner's participation in profits is limited to no more than the fixed dividends) is held by producers. Revenue Ruling 73-248.

  51. "Like organization" ; lumber marketing association—An incorporated organization that markets lumber for the independent lumber producing companies controlling such organization, whose members share in its surplus or deficit on the basis of their stock interests, does not qualify for exemption as a "farmers', fruit growers', or like association, and operated on a cooperative basis." I.T. 1312 superseded by Revenue Ruling 73-570. .

  52. Supplemental distributions—A supplemental distribution of earnings by an exempt farmers' cooperative to its patrons as the result of a 1973 audit disallowing depreciation deductions claimed on the 1970 and 1971 returns of the cooperative, whose bylaws obligate it to pay its patrons all net margins over and above operating expenses, will not qualify as a patronage dividend deduction in any year. The cooperative must pay tax on the amount of depreciation disallowed for each year and the tax payment should be reflected on its books as a deduction from net earnings of the respective year’s pool. The remaining amount may be distributed as a nonqualifying patronage dividend. Revenue Ruling 74-327.

  53. Equitable allocation—An exempt farmers' cooperative that operates a grain elevator branch, a soybean processing branch, and establishes a feed yard branch financed by selling preferred debentures to its members, that allocates the feed yard earnings between the debenture holders and the other branches according to the feed source, and allocates the grain and soybean branch's earnings according to the branch's individual patronage, thus resulting in debenture and nondebenture holders receiving different dividends for identical marketing, is using a method of operation that does not affect its exempt status. Revenue Ruling 74-567.

  54. Ingredient purchases from nonproducers—The purchase of cream from nonproducers by a dairy farmers' cooperative marketing association, that markets ice cream produced from the excess cream resulting from the processing of its member's raw milk, is not an ingredient purchase but is a product and will adversely affect the association’s exempt status. Revenue Ruling 75-4.

  55. Marketing range grasses—A nonprofit agricultural cooperative formed to produce and market range grasses, on land owned or leased by its members, by grazing its own herd of breeder cattle and by grazing the cattle of others during the peak growing season qualifies for exemption as a farmers', fruit growers', or like association. Revenue Ruling 75-5.

  56. Marketing and purchasing association; vote by proxy—The exempt status of a farmers' cooperative will not be jeopardized if it permits proxy voting by shareholders. Revenue Ruling 75-97.

  57. Milk quality bonus program—A milk quality bonus program, adopted by a dairy farmers’ cooperative association marketing milk only for its members, that is financed under contracts with milk handlers who in addition to the base price pay a premium that is shared by all the member/producers on the basis of points awarded according to each member’s milk quality is a permissible method of allocating income and does not adversely affect the association’s exempt status. Revenue Ruling 75-110.

  58. Purchasing subsidiary—A corporation formed to purchase farm equipment for members of an exempt farmers' cooperative that holds all issued capital stock of the corporation satisfies the requirement that substantially all of its stock must be owned by producers. Revenue Ruling 75-388.

  59. Marketing expenses—A cotton farmers' marketing cooperative that acquires a wool processing company in order to broaden the economic base of the cooperative so that its economic position does not rest solely upon the marketing of cotton will not qualify as an exempt organization under IRC section 521 because such acquisition costs are neither cotton marketing expenses nor connected with incidental investment activities properly deducted from a reserve account. Revenue Ruling 76-233.

  60. Hedging transactions—In certain circumstances, an exempt farmers' cooperative may establish a commodity division to serve as a commodity broker to facilitate hedging transactions for its marketing patrons without affecting its exemption. Revenue Ruling 76-298.

  61. Emergency and sideline purchases—An exempt farmers' cooperative, making emergency purchases and purchases of sideline products for fixed prices from a nonmember/nonproducer, is not required to pay patronage dividends to the nonmember/nonproducer to maintain its exempt status. Revenue Ruling 76-388.

  62. Processing goods—Farmers' cooperative operates a cannery and facilities for drying fruit and a farmers' cooperative operates textile mill. The cooperatives market the processed or unprocessed products of their member/growers and distribute the proceeds to them on the basis of the quantity of product furnished, less a charge to cover the cost of processing. It was held that the cooperatives qualify as exempt farmer’s cooperatives under IRC section 521. This revenue ruling exemplifies a long standing position of the Service concerning changing the basic form of members’ products and restates Item 3 of Mim. 3886, X-2 C.B. 164 (1931) . Revenue Ruling 77-384.

  63. Stock ownership requirements and voting requirements—Revenue Ruling 77-440 has been revoked by Revenue Ruling 90-42 because it applies the fifty-percent patronage test of Revenue Procedure 73-39 that was revoked by Revenue Procedure 90-29.

4.44.1.8.2  (01-01-2002)
Revenue Procedures

  1. Nonproducer items; guidelines for determining permissible limits of sales—Revenue Procedure 67-37 sets forth guidelines for determining the effect of retail selling to nonproducers items by an exempt farmers' cooperative organization as a sideline to facilitate the sale of products produced by the organization’s patrons. The guidelines are for use in the examination of annual returns, Form 990-C, Exempt Cooperative Association Income Tax Return. Revenue Procedure 67-37.

  2. Rulings; Procedures—The procedure with respect to processing exemption requests under IRC sections 501 and 521 and with respect to revocation or modification of exemption rulings and determination letters is revised. Revenue Procedure 72-4 superseded. Revenue Procedure 80-25.

  3. Federated cooperatives; "look through" principle; information and returns for exemption—Information from a member that a federated farmers' cooperative may rely on in establishing and maintaining exemption and information that should be submitted by the cooperative with its application for exemption and annual return; effective for years beginning after June 30, 1971. Revenue Procedure 72-16.

  4. ) Patron status as producer—The Tax Court rejected the 50-percent patronage requirement of Revenue Procedure 73-39 in Farmers Cooperative Company v. Commissioner, 89 T.C. 682 (1987), acq., 1988-2 C.B. 1, concluding that the patronage requirement of IRC section 521(b)(2) is qualitative, not quantitative. A person who transacts no patronage whatsoever during the cooperative's taxable year may still be considered a producer under IRC section 521(b)(2) if, upon consideration of all the facts and circumstances, it is determined such person was unable to transact any patronage during the year because of crop failure, sickness, hardship, etc. Revenue Procedure 90-29 revoked Revenue Procedure 73-39.


More Internal Revenue Manual