4.44.1 IRC section 521 Exempt Farmers’ Cooperatives

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.

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.

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.

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).

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

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.

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

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).

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).

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.

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.

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.

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).

Miscellaneous Definitions

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

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.

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.

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).

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.

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.

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.

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.

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).

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.

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).

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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.

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.

Miscellaneous

  1. Allocation of nonpatronage income—Taxpayer, an exempt farmers' cooperative, carried on purchasing activities through its feed and fertilizer departments, and storage and selling activities through its grain department. Substantially all the patrons of the grain department were also patrons of the other two departments. Taxpayer received nonpatronage income from the Commodity Credit Corporation, for the storage and handling of grain, which it allocated only to patrons of its grain department. Held, taxpayer’s method of allocation was acceptable and the amounts so allocated were deductible. Juniata Farmers Cooperative Assn., 43 T.C. 836, Acq., 1966-1 C.B. 2.

  2. By-products sold nonproducers—A farmers' cooperative engaged in the production and distribution of petroleum products may disregard sales on the open market of by-products not usable by its patrons and the value of petroleum products exchanged with other refineries, in order to utilize its output and save unnecessary transportation costs, in determining whether its purchases for persons who are neither members nor producers exceed 15-percent of the value of all purchases. Revenue Ruling 54-12; distinguished by Revenue Ruling 67-346, dealing with exchanges for an unlike product; modified to provide that the sale of by-products to nonproducers may not, after August 4, 1969, be disregarded in computing the 15-percent limitation, Revenue Ruling 69-417. Revenue Ruling 54-12; Revenue Ruling 69-417.

  3. Federated; "look through" principle—The effect on the exempt status of federated farmers' cooperatives in applying the "look through" principle is illustrated in the following situations (Revenue Rulings 72-50, 72-51 and 72-52):

    1. A supply cooperative purchases supplies from commercial sources and sells them at a profit to nonmembers;

    2. A supply cooperative purchases supplies for a nonexempt member; and

    3. A nonexempt member handles fungible products and markets through both the farmers' cooperative and commercial sources.

  4. Federated; "look through" principle—Four situations illustrate the principle of "looking through" to ultimate patrons of member associations in determining whether a federated farmer’s cooperative meets the requirements for exemption. Situation two through four involving federated cooperatives dealing with nonexempt cooperatives will not be applied to taxable years beginning before July 1, 1970, with respect to federated cooperative associations that have been relying on rulings or determination letters of exemption issued under IRC section 521. Revenue Ruling 69-651 is modified by Revenue Ruling 71-493 to postpone to July 1, 1971, the effective date of situations two through four, and suspended by Revenue Ruling 72-17. Revenue Ruling 73-138 is revoked by Revenue Ruling 73-568. The provisions of Revenue Ruling 69-651 as set forth in situations two through four will not be applied to taxable years beginning before December 17, 1973. Revenue Ruling 69-651; Revenue Ruling 71-493; Revenue Ruling 73-138; Revenue Ruling 73-568.

  5. Federated; "look through" principle—Methods are provided that may be used by a federated farmers' cooperative whose taxable year differs from some of its member cooperatives, in establishing and maintaining its exemption under IRC section 521 for the purpose of the "look through" principle. Supplemented to provide an additional method. Revenue Procedures 72-17 and 73-38.

  6. Patron’s status as producer—Farm owners operating their farms through tenants are producers, and where the number of those operating their own farms and those operating through tenants constitutes substantially all of the membership of a cooperative association operating a creamery, such an association is entitled to exemption. Farmers Co-operative Creamery, 21 B.T.A. 265, acq. 1957-2 C.B. 4.

Subchapter T Treatment of Exempt and Non-Exempt Cooperatives

Special Deductions for Subchapter T Cooperatives

  1. A Subchapter T cooperative (whether taxable or nontaxable) may deduct from gross income, in arriving at taxable income, all amounts paid during the payment period for the taxable year:

    1. As patronage dividends, to the extent paid in cash or property (other than nonqualified notices of allocation) and qualified written notices of allocation with respect to patronage occurring during such taxable year.

    2. In redemption of a nonqualified written notice of allocation which was paid as a patronage dividend, during the payment period for the taxable year during which the patronage occurred, and if the redemption is paid in cash or property other than a written notice of allocation.

  2. A Subchapter T cooperative (whether or not taxable) may exclude from gross income, in arriving at taxable income, all amounts paid during the payment period for the taxable year:

    1. As per-unit retains to the extent paid in money, a qualified per-unit retains certificate or other property (other than nonqualified per-unit retains certificates), with respect to marketing occurring during such taxable year.

    2. In redemption of a nonqualified per-unit retain certificate which was paid as a per-unit retain allocation during the payment period for the taxable year in which the marketing occurred and which is paid in money or other property (other than per-unit retain certificates).

  3. In other words, a patronage dividend is not deductible in computing taxable income unless it is paid during the prescribed payment period, in money, a qualified written notice of allocation, or other property.

    1. However, if a patronage dividend is paid by a nonqualified written notice of allocation and is paid within the prescribed payment period, then when such nonqualified notice is redeemed in money or property, the amount of the money or property is deductible in computing taxable income.

    2. A written notice of allocation is considered "paid" when it is issued to the patron. See Treas. Reg. 1.1382–2(b).

  4. Generally, the allowable deduction for a written notice of allocation is limited to the face value of the notice, or the fair market value of the property, when paid. See Treas. Reg. 1.1382–2(c). In the case of redemption of a timely issued written notice of allocation, the deduction for cash or the property’s fair market value is limited to the notice’s stated value. Any excess is handled under other Internal Revenue Code sections; thus, excess interest would be governed by IRC section 163.

  5. Concerning the redemption of per-unit retains, if the cooperative has no taxable income for the year in which it redeems nonqualified per-unit retain certificates, the amount of the nonqualified certificates can, in effect, be carried back to the year issued (and the tax recomputed for that year, allowing a deduction for the amount of the certificates).

  6. In the case of pooling arrangements, patronage occurs in the year the pool closes. See Treas. Reg. 1.1382–5.

    Example:

    A farmer delivers wheat to a cooperative pool in July 1963, and receives a cash advance. In October 1963, he receives an additional cash advance. These cash advances are income to the farmer in the year of receipt. The cooperative sells some of the pooled wheat in October 1963, and the rest in January 1964. The pool is closed on February 15, 1964. The farmers' patronage is considered as occurring in 1964.

Additional Deductions for Exempt Farmers’ Cooperatives
  1. A cooperative association exempt under IRC section 521 may also deduct, in computing its taxable income:

    1. Amounts paid during the taxable year as dividends on its capital stock; and

    2. Amounts paid during the "payment period" for the taxable year in money, qualified written notices of allocation, or other property (except nonqualified written notices of allocation) on a patronage basis to patrons with respect to earnings during such taxable year which are derived from nonpatronage sources including business done for the United States, or in money or other property (except written notices of allocation) in redemption of a nonqualified written notice of allocation which was paid, during the payment period for the taxable year during which the earnings were derived, on a patronage basis to a patron with respect to earnings derived from nonpatronage sources. See IRC section 1382(c).

  2. Further, the dividends paid by an exempt cooperative on capital stock, may be deducted only in the year in which actually or constructively paid, without regard to when the earnings were derived. See IRM 4.44.1.1.2.6, for the definition of capital stock.

  3. A tax-exempt farmers' cooperative may also deduct amounts paid to patrons, during the payment period for the taxable year, on a patronage basis, with respect to its earnings derived from business done with or for the United States or any of its agencies and from sources other than patronage (such as interest income).

  4. In order that the deduction may apply to amounts paid with respect to income derived from business done with or for the United States or any of its agencies, or from sources other than patronage, it is necessary that the amount to be deducted be paid on a patronage basis in proportion, insofar as is practicable, to the amount of business done by or for patrons during the period to which such income is attributable. See Treas. Reg. 1.1382–3(c)(3).

  5. For example, if capital gains are realized from the sale or exchange of capital assets acquired and disposed of during the taxable year, income realized from such gains must be paid to patrons of such year in proportion to the amount of business done by such patrons during the taxable year.

  6. Thus, if capital gains are realized by the association because of the sale or exchange of capital assets held for a period extending into more than one taxable year, income realized from such gains must be paid, insofar as is practicable, to the persons who were patrons during the taxable years in which the assets were owned by the association in proportion to the amount of business done by such patrons during such taxable years. See Treas. Reg. 1.1382-3(c)(3). See IRC section 453(d) and Revenue Ruling 68-332 for application of the installment method to such sale or exchange.

  7. Amounts representing unclaimed allocations of nonpatronage income paid over to a state by an exempt cooperative pursuant to the escheat law of the state are deductible by the cooperative under IRC section 1382(c), provided that the escheat law is custodial in nature. See Revenue Ruling 68-423.

  8. A deduction for nonpatronage income earned by an IRC section 521 exempt farmers' cooperative and allocated during the taxable year to patrons is permitted, regardless of the year in which the nonpatronage income was actually earned. Allocations made after the close of the taxable year and on or before the 15th day of the ninth month following the close of the taxable year shall be considered as made on the last day of such taxable year to the extent that such allocations are attributable to income derived during the taxable year or prior thereto.

  9. Generally, the nonpatronage source income mentioned above is the only difference between an exempt farmers' cooperative and a taxable farmers' cooperative (interest income, dividends paid on capital stock, and business with the U.S. government). All corporations filing as a cooperative under subchapter T must meet and follow subchapter T of the Internal Revenue Code. See IRC sections 6072(d) and 1381(a).

Definitions

  1. Many terms relating to farmers' cooperatives have unique meanings for purposes of the Internal Revenue Code. These terms, which are discussed below, include: cooperative, patron, patronage dividend, written notice of allocation (both qualified and nonqualified), per-unit retain certificate (both qualified and nonqualified), consent, qualified check, and payment period.

Cooperative
  1. "Cooperative" is not defined in the Internal Revenue Code. However, a cooperative is a type of organization formed for the purpose of providing goods or services for its patron-owners, or selling their products. For the purposes of Subchapter T, the term "cooperative" includes:

    • Taxable farmers' cooperatives, which are the principal type of cooperative

    • Farmer’s cooperatives exempt under IRC section 521

    • Cooperative wholesaling businesses owned by retailers

    • Cooperative housing corporations (not discussed in this IRM section

    • Urban consumer cooperatives (not discussed in this IRM section)

  2. For a cooperative to be described in subchapter T, it must be "operating on a cooperative basis" within the meaning of IRC section 1381(a)(2). It must have the three traditional characteristics of cooperative operation, namely subordination of capital, democratic control, and operation at cost. Any cooperative that meets these three requirements can file its tax returns under subchapter T (e.g., farmers' cooperatives, housing cooperatives, and wholesale cooperatives). See Trump Village v. Commissioner, T.C. Memo 1995-281, AOD/CC-1995-011, (Oct 30, 1995).

  3. Subchapter T does not apply, per Treas. Reg. 1.1381-1, to:

    1. Mutual savings banks, cooperative banks, or building and loan associations;

    2. Insurance companies; or

    3. Organizations engaged in furnishing electricity or providing telephone service to persons in rural areas. These organizations may be tax exempt under IRC section 501(c)(12) and file a Form 990 return. If not exempt, they file a Form 1120 return.

Patron
  1. A "patron" is any person, as defined in IRC section 7701(a)(1), with whom or for whom the cooperative does business on a cooperative basis (whether a member or a nonmember of the cooperative, per Treas. Reg. 1.1388-1(e)), and who bears some risk of loss from dealings with the cooperative. See Revenue Rulings 76-388 and 66-380 (a producer that purchases from the cooperative is not necessarily dealing with the cooperative on a cooperative basis).

Patronage Dividend
  1. The definition of patronage dividend includes a discussion of:

    1. The patronage dividend;

    2. What is not a patronage dividend; and

    3. Income from sources other than patronage (such income never qualifies as a patronage dividend).

Patronage Dividends Defined
  1. The term "patronage dividend" means an amount paid to a patron by a cooperative which is paid (per IRC section 1388(a)):

    1. On the basis of quantity or value of business done with, or for, such patron,

    2. Under a preexisting valid enforceable written obligation of such organization to the patron to pay such amount, and

    3. Which is determined by reference to the net earnings of the cooperative from business done with, or for, its patrons.

  2. Amounts paid by a cooperative are paid under a valid enforceable written obligation if such payments are required by State law or are paid pursuant to provisions of the by-laws, articles of incorporation, or other written contract, whereby the organization is obligated to make such payment. The term "net earnings," for purposes of determining patronage dividends, includes the excess of amounts retained (or assessed) by the organization to cover expenses or other items over the amount of such expenses or other items. Net earnings shall not be reduced by any taxes imposed by subtitle A of the Internal Revenue Code, but shall be reduced by dividends paid on capital stock or other proprietary capital interests. See Revenue Ruling 74-161, concerning certain state taxes paid.

Not A Patronage Dividend
  1. Treas. Reg. 1.1388-1(a)(2) clarifies that the term "patronage dividend" does not include the following:

    1. An amount paid to a patron by a cooperative to the extent that such amount is paid out of earnings not derived from business done with or for patrons;

    2. An amount paid to a patron by a cooperative to the extent that such amount is paid out of earnings from business done with, or for, other patrons to whom no amounts are paid, or to whom smaller amounts are paid, with respect to substantially identical transactions. Thus, if a cooperative does not pay patronage dividends to nonmembers, any portion of the amounts paid to members which is out of net earnings from patronage with nonmembers, and which would have been paid to the nonmembers if all patrons were treated alike, is not a patronage dividend;

    3. That portion of a capital stock dividend that is charged against net earnings from nonmember business. See Revenue Ruling 68-228. The dividend should be ratably charged against all net earnings;

    4. An amount paid to a patron by a cooperative to the extent that such amount is paid to redeem instruments other than written notices of allocation, even if such instruments were originally paid as patronage dividends;

    5. An amount paid to a patron by a cooperative to the extent that such amount is fixed without reference to the net earnings of the cooperative organization from business done with or for its patrons. See Treas. Reg. 1.1388-1(a)(2). However, such amount might be a per unit retain. See IRM 4.44.1.9.2.5.1 (per-unit retain certificates) and IRM 4.44.1.9.2.5.2 (qualified per-unit retain certificates).

  2. Patronage source income is generally easy to identify. For example, a cooperative that markets (sells) grain (wheat, corn, soybeans, etc.) bought from patron/members, would be patronage source. If the cooperative "processes" wheat, for example, and the wheat is "blended" with other ingredients to make "bread", the final product, bread, is patronage source because the main ingredient is wheat. Other nonmember purchased ingredients make up a small portion of the final product, bread. However, if the cooperative makes and processes "margarine", the ingredient wheat may be so small a portion of the final product (e.g., 2%) that the net income from the margarine sales would be nonpatronage source (the other "nonmember" purchased ingredients are 98%). Many larger cooperatives enhance "profit margins" by processing patron/member commodities and provide the patron/member with a larger "patronage dividend". Careful analysis must be done for each commodity if a cooperative "processes" commodities of patron/members.

Income From Sources Other Than Patronage
  1. Treas. Reg. 1.1382–3(c)(2) defines "income derived from sources other than patronage" as incidental income derived from sources not directly related to marketing, purchasing, or service activities of the cooperative. This regulation cites leases of premises, investments in securities, and sales or exchanges of capital assets as examples of nonpatronage source income; the regulation has been substantially eroded by case law.

  2. Cases like C.F. Industries. Inc. v. Commissioner, 62 T.C.M. 1249 (1991), aff’d and modified by 93–1 U.S.T.C. para. 50,313 (7th Cir.), modified by 67 T.C.M. 2397 (1994) (court concluded interest income was patronage sourced); Cotter & Co. v. United States, 85–2 U.S.T.C. para. 9487 (Fed. Cir. 1985) and Illinois Grain Corporation v. Commissioner, 87 T.C. 435 (1986) (courts concluded both interest and rental income were patronage sourced) all demonstrate the court’s rejection of the regulation’s attempt to apply a per se rule to the characterization of specific types of income as nonpatronage sourced. Interest income, rental income, gain on sale of assets, etc., could be patronage source if the activity actually facilitates the accomplishment of the cooperative's business activity, (an integral part of member business). See Revenue Rulling 69-576.

  3. ) The sale of securities (stock) is nonpatronage source as stated in Treas. Reg. 1.1382-3(c)(2). The Court in Farmland Industries Inc. v. Commissioner, T.C. Memo 1999-388, 1999, determined that the gain on the sale of stock owned by the cooperative was patronage source. The Court declined to adopt the per se nonpatronage rule for capital gains and losses in the regulations. The Court maintained the ”directly related” test to distinguish patronage and nonpatronage items of income and loss for this cooperative.

  4. The Court determined in Arkansas Best Corporation v. Commissioner, (Sup. Ct.), 88-1 USTC, that the sale of stock was a "capital asset" within the meaning of IRC section 1221 regardless of whether such stock was purchased and held for a business purpose or for an investment purpose. This Court reviewed its decision in Corn Products Refining Co. v. Commissioner and concluded that a taxpayer's motivation in purchasing an asset is irrelevant to the question of whether the asset is a capital asset as defined in IRC section 1221. Arkansas Best, Inc. was not a cooperative.

    1. The sale of stock is a capital asset, but as determined inFarmland Industries Inc. v. Commissioner, the gain can be patronage source.

  5. The Court determined in Circle K Corporation v. United States, (Ct. Cls.), 91-1 USTC, that the sale of stock of an oil company was an ordinary loss. The Court concluded the purchase of stock was an integral part of the company's inventory purchase system and was excluded from the definition of a capital asset because the option constituted "stock in inventory". The stock was purchased and later converted into an option agreement to guarantee the company a source of gasoline for its retail operations for any future gasoline supplies or shortages. Because the company was in the business of selling gasoline and other petroleum products, it needed a source of supply and the stock purchase was an integral part its operations and would qualify as a hedging transaction and the loss on the sale of stock was an ordinary loss. As in Corn Products, the Court determined that the company's purchase of stock was for its supply of inventory for its business operations.

  6. Case law indicates that the determination of whether income is derived from sources other than patronage is very fact intensive. If the transaction producing the income merely enhances the overall profitability of the cooperative, being merely incidental to the cooperative's operation, the income is from a nonpatronage source. But if the source of income or loss is from an activity that is an integral part of the cooperative's business (e.g., inventory), then the source may be patronage. See Revenue Ruling 69-576.

  7. That part of the gain (or loss) related to any nonmember business would be nonpatronage source. For example, if the bylaws provide that only members receive a patronage dividend and if 75-percent of the same business activity are members and 25-percent are not members, then any income (or loss) would be allocated 75-percent to members as a patronage dividend and 25-percent would be taxable on the cooperative return Form 990-C or 1120. Some cooperative bylaws allow patronage dividends to be paid to "all patrons" whether member or nonmember. In this case, the patronage dividend deduction would be allowed as a deduction for "all patrons", not only members.

  8. There are two Coordinated Issue Papers regarding farmers' cooperative issues. One position is that the gain or loss on the disposition of capital stock is nonpatronage source income to a cooperative. The other position is that rental income and backhauling goods for nonpatrons are nonpatronage for both sources of income. The facts and circumstances must be considered in all situations to determine if the activity is patronage or nonpatronage source. A Coordinated Issue Paper may become a Decoordinated Issue paper. Examiners need to determine the current status of any Coordinated Issue Paper and contact and discuss the issue with the Industry Technical Advisor.

  9. There are a number of Private Letter Rulings (PLRs) issued for cooperatives. Although each PLR applies to a particular cooperative, insight can be gained in similar applications for other cooperatives. In situations where it is difficult to determine whether the source of income or loss is patronage or nonpatronage, the examiner may need to request a Technical Advice Memorandum.

Written Notice of Allocation
  1. The term "written notice of allocation," whether qualified or nonqualified means: any capital stock, revolving fund certificate, retain certificate, certificate of indebtedness, letter of advice, or other written notice, which discloses to the patron the stated dollar amount allocated to him on the books of the cooperative organization, and the portion thereof, if any, which constitutes a patronage dividend.

  2. A mere credit to the account of a patron on the books of the organization without disclosure to the patron, is not a written notice of allocation. A written notice of allocation may disclose to the patron the amount of the allocation which constitutes a patronage dividend either as a dollar amount or as a percentage of the stated dollar amount of the written notice of allocation. See Treas. Reg. 1.1388–1(b).

Qualified Written Notice of Allocation
  1. A "qualified written notice of allocation" is a written notice of allocation which is paid as part of a patronage dividend or, in the case of an exempt cooperative, as part of a patronage or nonpatronage dividend. A written notice of allocation is "qualified" if:

    1. It is redeemable within 90 days of notice, or

    2. The distributee/patron has consented, within the meaning of IRM 4.44.1.9.2.6 (IRC section 1388 consent) to take such amount into account at its stated amount.

    3. In either case, at least 20-percent of the patronage dividend must be paid in money or by "qualified check," per IRC section 1388(c). (In effect, the patron/member loans the cooperative 80-percent of the total amount of the patronage dividend due him/her. The patron/member includes 100-percent of the patronage dividend in his/her taxable income.)

  2. The 90-day redemption period begins on the date the written notice is paid and ends not earlier than 90 days from such date. The distributee must receive written notice of the right of redemption at the time he receives the written notice of allocation. The written notice of the right of redemption shall be given separately to each patron. Thus, a written notice of the right of redemption which is published in a newspaper or posted at the cooperative’s place of business does not "qualify" an otherwise qualified written notice of allocation.

  3. In determining whether 20-percent of a patronage dividend or a payment with respect to nonpatronage earnings is paid in money or by qualified check, any portion of such dividend or payment which is paid in nonqualified written notices of allocation may be disregarded. Thus, if a cooperative pays a patronage dividend of $100 in the form of a nonqualified written notice of allocation with a stated dollar amount of $50, a written notice of allocation with a stated dollar amount of $40, and money in the amount of $10, then the written notice of allocation with a stated dollar amount of $40 constitutes a qualified written notice of allocation if it satisfies IRM 4.44.1.9.2.4.1(1)(a) or (b).

  4. Under Treas. Reg. 1.1388-1(c)(i), a "payment in money" includes a payment by a check drawn on a bank but not:

    1. Other documents redeemable in money.

    2. A credit against the patron’s debt to the cooperative.

    3. A credit toward cooperative membership or stock.

  5. "Payment in money" means the minimum 20-percent payment must be in cash or a check drawn on a bank. However, the remaining 80-percent of the patronage dividend can be in the form of stock or a membership fee for the patron to become a member of the cooperative. Any remainder would be in the form of some type of stock or paper recorded on the books of the cooperative.

Nonqualified Written Notice of Allocation
  1. The term "nonqualified written notice of allocation" means a written notice of allocation that is not qualified or a qualified check that is not cashed on or before the 90th day after the close of the payment period for the taxable year of the organization for which the payment, of which it is a part, is paid. See IRC section 1388(d).

Per-Unit Retain Certificates
  1. A per-unit retain certificate is a written notice which discloses to the recipient the stated dollar amount of a per-unit retain allocation to the recipient by the cooperative. See IRC section 1388(g).

  2. IRC section 1388(f) defines a per-unit retain allocation as any allocation, made by a Subchapter T cooperative, other than payment in money or other property (except per-unit retain certificates) to a patron with respect to products marketed for him/her, the amount of which is fixed without reference to the net earnings of the organization, pursuant to an agreement between the organization and the patron.

    Note:

    Per-unit retain allocations made after October 9, 1969, may be paid in money or other property.

Qualified Per-Unit Retain Certificates
  1. IRC section 1388(h) and (i) define the terms "qualified" and "nonqualified" per-unit retain certificates. A "qualified" per-unit retain certificate is similar to a "qualified written notice of allocation" (issued with respect to patronage dividends) except that:

    1. No 20-percent payment in money is required for a qualified per-unit retain certificate, and

    2. The methods of obtaining consent from an individual are limited to written consent and bylaw consent methods. See IRM 4.44.1.9.2.6 for details of IRC section 1388 consent.

Nonqualified Per-Unit Retain Certificates
  1. A nonqualified per-unit retain certificate is a per-unit retain certificate that is not defined at IRC section 1388(h).

IRC section 1388 Consent Overview
  1. A cooperative may enjoy certain favorable tax treatment if it obtains the patron’s consent to take certain amounts into account (income) The three types of consent are:

    1. Individual consent, in writing (can be revoked at any time);

    2. By-law consent, which is also subject to revocation; and

    3. Consent by qualified check

  2. There are special rules for individual and by-law consents used in pooling agreements.

"Individual Consent"
  1. There are several methods for obtaining IRC section 1388 individual consent. A distributee may consent to take the stated dollar amount of written notices or allocation into account by signing and furnishing a written consent to the cooperative. In such case, no special form is required for the written consent so long as the document on which it is made clearly discloses the terms of the consent. Thus, the written consent may be made on a signed invoice, sales slip, delivery ticket, marketing agreement, or other document. Unless the written consent specifically provides to the contrary, it shall be effective with respect to all patronage occurring during the taxable year of the cooperative in which such consent is received by such cooperative and, unless revoked under IRC section 1388(c)(3)(B), for all subsequent taxable years.

  2. IRC section 1388(c)(3)(B)(i) provides that a written consent may be revoked by the patron at any time. Thus, any written consent which is, by its terms, irrevocable, is not a consent that would qualify a written notice of allocation. An effective revocation must be in writing, signed by the patron, and furnished to the cooperative. Such a revocation shall be effective only with respect to patronage occurring after the close of the taxable year of the cooperative during which the revocation is filed.

  3. In the case of a pooling arrangement (see IRM 4.44.1.9.3), a written consent which is made at any time before the close of the taxable year of the cooperative during which the pool closes, shall be effective with respect to all patronage under the pool. In addition, any subsequent revocation of such consent by the patron is ineffective for that pool or any other pool he patronized before such revocation, per Treas. Reg.1.1388–1(c)(3)(i).

Consent Via By-Law
  1. Treas. Reg. 1.1388-1(c)(3) prescribes the method for obtaining by-law consent and clarifies that by-law consent is effective only as long as the by-law is valid against the member whose consent is at issue. See Treas. Reg. 1.1388–1(c)(3)(ii).

    1. A distributee may consent to take the stated dollar amount of written notices of allocation into account by obtaining or retaining membership in the cooperative organization after such organization has adopted a valid by-law, providing that membership in such cooperative organization constitutes such consent.

    2. However, such consent shall take effect only after the distributee has separately received a written notification of the adoption of the by-law provision and a copy of such by-law.

    3. The by-law must have been adopted by the cooperative organization after October 16, 1962, and must contain a clear statement that membership in the cooperative organization constitutes the prescribed consent. A written notice and copy of the bylaw which is published in a newspaper or posted at the cooperative’s place of business is not sufficient to qualify a written notice of allocation under this subdivision.

    4. A member (or prospective member) is presumed to have received the notification and copy of the by-law if they were sent to the member’s last known address by ordinary mail. A prospective member must receive the notification and copy of the by-law before becoming a member of the organization so that membership in the organization will constitute consent. See Independent Co-op Milk Producers v. Commissioner, 76 T.C. 1001 (1981).

  2. In the case of a pooling arrangement, consent made by membership will be effective only with respect to the patron’s actual patronage occurring after the patron receives the notification and copy of the by-law and while the patron is a member of the cooperative. See IRM 4.44.1.9.3. Such a consent shall not be effective with respect to any patronage under a pool after the patron ceases to be a member of the cooperative organization or after the by-law provision is repealed by the organization. See Treas. Reg. 1.1388–1(c)(3)(ii).

Consent By Qualified Check
  1. This subparagraph clarifies the method for obtaining consent by qualified check and the effect of such consent.

    1. A distributee may consent to take the stated dollar amount of a written notice of allocation into account by endorsing and cashing a qualified check which is paid as a part of the same patronage dividend or payment described in section (qualified written notice of allocation) of which the written notice of allocation is also a part.

    2. To constitute an effective consent however, the qualified check must be endorsed and cashed by the payee on or before 90 days after the close of the payment period for the taxable year of the cooperative organization with respect to which the patronage dividend or payment is paid (or on or before such earlier day as may be prescribed by the cooperative organization).

    3. The endorsing and cashing of a qualified check is considered a consent only with respect to written notices of allocation which are part of the same patronage dividend or payment as the qualified check and for which a consent is not in effect.

    4. A qualified check is presumed to be endorsed and cashed within the 90-day period if the earliest bank endorsement which appears thereon bears a date no later than 3 days after the end of such 90-day period (excluding Saturdays, Sundays, and legal holidays).

Qualified Check Defined
  1. A "qualified check" is a check, or other instrument redeemable in money by the cooperative, which is paid as a part of the patronage dividend or payment (as described in IRM 4.44.1.9.2.4.1 (qualified written notice of allocation), on which there is clearly imprinted a statement that the endorsement and cashing of the check or other instrument constitutes the consent of the payee to take into account, as provided in the federal income tax laws, the stated dollar amount of any written notices of allocation which are paid as a part of the patronage dividend or payment of which such check or other instrument is also a part. See Treas. Reg. 1.1388–1(c)(3)(iii)(b).

  2. A qualified check need not be in the form of an ordinary check which is payable through the banking system. It may, for example, be in the form of an instrument which is redeemable in money by the cooperative organization. See Treas. Reg. 1.1388–1(c)(3)(iii)(b).

  3. The term "qualified check" does not include a check or other instrument paid as part of a patronage dividend, or payment, with respect to which a consent is already in effect. In addition, the term "qualified check" does not include a check or other instrument which is paid as part of a patronage dividend or payment, if such patronage dividend or payment does not also include a written notice of allocation (other than a written notice of allocation that is described in IRC section 1388(c)(1)(A)). Thus, a check which is paid as part of a patronage dividend is not a qualified check (even if it has the required imprinted statement) if the remaining portion of such patronage dividend is paid in cash or if only qualified written notices of allocation are included in the payment. See Treas. Reg. 1.1388–1(e)(3)(iii). Also, see IRM 4.44.1.9.2.6.3 (consent by qualified check) for the effect of endorsing and cashing a "qualified check" and for the method of obtaining IRC section 1388 consent by use of a "qualified check."

Payment Period Overview
  1. The term "payment period" is defined in IRC section 1382(d).

  2. IRC section 1382(e) clarifies the beginning of the "payment period" for cooperatives engaged in pooling arrangements.

  3. IRC section 1382(f) clarifies an aspect of the payment period for patronage sourced earnings that are received after patronage has occurred.

  4. The "payment period" for any taxable year of a cooperative is the period beginning with the first day of the taxable year and ending on the fifteenth day of the ninth month following the close of such year. See IRC section 1382(d).

    1. For example, the payment period for taxable year 2000 for a calendar year cooperative is January 1, 2000, through September 15, 2001.

    2. Any allocation of the earnings for such taxable year that are made after the payment period must be taken into account in computing a cooperative’s taxable income, and no deduction nor exclusion is permitted therefor, neither when the allocation is made nor when it is redeemed. See IRM 4.44.1.9.3 regarding the IRC section 1382(e) patronage timing rules for pooling arrangements. IRC section 1382(f) is explained in IRM 4.44.1.9.2.8.1, which concerns treatment of earnings received after patronage occurred.

  5. Two examples follow:

    1. Cooperative X reports on the calendar-year basis, so its payment period for each taxable year expires on the following September 15. On September 1, 1964, it issues a qualified written notice of allocation to one of its patrons, with respect to patronage occurring in 1963. On October 1, 1964, one month later, it issues another qualified written notice of allocation to another patron for patronage which also occurred in 1963. The face amount of the notice issued on September 1 may be deducted in computing the cooperative’s taxable income for 1963, but no amount may be deducted for 1963 with respect to the notice issued on October 1. Moreover, since the allocation made on October 1, 1964, pertains to patronage in 1963, the amount of the allocation is not deductible in 1964.

    2. Cooperative Y reports on the calendar-year basis. On August 15, 1964, it issues a nonqualified written notice of allocation to patron A, with respect to patronage occurring in 1963. On October 15, 1964, two months later, it issues a nonqualified written notice of allocation to patron B, also for patronage occurring in 1963. Since these notices are nonqualified, the amounts represented thereby may not be deducted in computing the cooperative’s taxable income for 1963. Assume further, however, that the cooperative redeems both notices, in cash, on July 1, 1966. These redemptions are within the payment period for the cooperative’s taxable year 1965, and since the notice issued to patron A was issued within the payment period for 1963, the year in which the related patronage occurred, the cash redemption price of A’s notice is deductible in computing the cooperative’s taxable income for 1965. The cooperative may not take the deduction in 1966 according to Treas. Reg. 1.1382–2(c). B’s notice was not issued within the payment period for 1963; therefore, the redemption price of her notice may not be deducted in computing the cooperative’s taxable income for any year. Nonetheless, B must include the redemption price of her notice in her gross income. (This illustrates a double taxation of the same income, rather than the single tax paid by the patron/member if the written notice is properly and timely provided to the patron/member).

Treatment of Earnings Received After Patronage Occurred
  1. Patronage derived earnings received by a cooperative subsequent to the taxable year the patronage occurred are deemed to be derived from patronage occurring in a year that such earnings are included into the cooperative’s gross income. See IRC section 1382(f).

  2. If a cooperative pays (distributes) earnings out as patronage dividends to any patron in the form of qualified written notices of allocation, money, or other property (other than written notices of allocation) during the payment period for the taxable year for which the earnings are includible in its gross income then, the cooperative will be allowed a patronage dividend deduction for such payments under IRC section 1382(b)(1). See Treas. Reg. 1.1382-6.

  3. See Revenue Ruling 57-358, which gives an example of patronage based earnings that are received subsequent to the year the patronage occurred, and Revenue Ruling 70-249 for an(example of application of IRC section 1382(f).

Pooling Arrangements

  1. Only those payments from each pool which the cooperative pays to its patrons and which are determined with reference to the cooperative’s net earnings with respect to such pool or pools, may qualify as patronage dividends. These amounts are determinable only in the taxable year each pool closes. Marketing is deemed to occur during any taxable year the pool is open.

  2. For an accrual basis cooperative, if all pools are not yet closed, then the all-events test has not been passed. In such case, amounts set up, at the close of each taxable year, on the books of an accrual basis cooperative as amounts due patrons are not yet deductible by the cooperative nor includible by the patron. See Revenue Ruling 67-333.

  3. The "completed pool" method of accounting is not an acceptable method of accounting for federal income tax purposes. See Revenue Ruling 69-71.

  4. Furthermore, inventories of unmarketed commodities on hand at the end of the taxable year of a farmers’ cooperative operating under a pooling arrangement should be valued at cost. See Revenue Ruling 69-67. However, the Court in St. James Cooperative, Inc. v. United States of America, United States Court of Appeals, Fifth Circuit, 643 F 2d 1229, 1981, determined that inventory, under a pooling arrangement, can be valued at market not to exceed net realizable value. Here, the Court said the "net realizable method" was appropriate. A careful examination of when the pool closes after the taxable year-end or during the year has to be done.

  5. For special pooling arrangement rules applicable to IRC section 1388 consent, see IRM 4.44.1.9.2.6.1 (individual consent) or IRM 4.44.1.2.9.6.2 (by-law consent).

Treatment of Certain Distributions by Patrons

  1. Generally, a patron must include all patronage dividend income, including any nonpatronage income derived from an exempt farmers' cooperative, into income. However, where such distributions relate to personal living or family items, these are not included in taxable income. Refer to IRC section 1385(b).

  2. IRC section 1385(c) provides for:

    1. The redemption of certain nonqualified written notices of allocation or nonqualified per-unit retains gives rise to ordinary income to the extent the stated dollar amount exceeds basis; and

    2. Certain qualified written notices of allocation and non-qualified per-unit retains have zero basis, or transferred basis if acquired from a decedent.

Price Support Loans

  1. A careful review of income should be done in determining the amount of nonpatronage income earned by a cooperative in connection with price support loans advanced by the Commodity Credit Corporation (CCC) for crops purchased from producers.

    Example:

    Price support loans are made and the crop is pledged as security. If the crop is sold for an amount in excess of the loan plus handling charges, etc., one-half of the excess, called overplus, is distributed to the cooperative, and is included in gross income in the year of receipt. The remaining one-half overplus retained by the CCC may be applied to the outstanding indebtedness of any other crop year of the cooperative. The cooperative does not include in its gross income any part of the one-half overplus retained by the CCC until the excess of retained overplus over its outstanding indebtedness to the CCC can be determined with reasonable accuracy. See Revenue Ruling 57-358.

  2. When, as part of the price support program, money is loaned to a producer on the strength of her warehouse receipt for grain stored in the cooperative, storage charges paid by the CCC for the period prior to default are income allocable to members as patronage dividends. The storage charges paid by the CCC for the period following default constitutes nonpatronage sourced income, as the grain at that time belongs to the CCC. See Revenue Ruling 59–107.

Accounting Rules Overview

  1. farmers' cooperatives may carryback or carryforward net operating losses.

  2. Patronage losses may offset patronage gains (bylaws will indicate how losses are allocated), but patronage losses cannot offset nonpatronage gains.

Net Operating Loss
  1. If a cooperative sustains a net operating loss, as defined in IRC section 172(c), the net operating loss may be carried back or forward to offset taxable income (after the allowance of the patronage dividend deduction) in the same manner and to the same extent as an ordinary corporation’s net operating loss. The cooperative’s constitution or by-laws may specifically provide for the treatment of losses. Such documents should be examined to verify compliance with the loss provisions.

  2. The Service will follow the decision in Buckeye Countrymark v. Commissioner. In this case, an operating loss was carried back by the nonexempt (not exempt under IRC section 521) cooperative under IRC section 172. The Service argued that cooperatives are "member organizations" described in IRC section 277. Under IRC section 277, member losses cannot be carried back (only forward). The Tax Court held that IRC section 277 does not apply to cooperatives subject to subchapter T of the Code (IRC sections 1381-1388). This holding is consistent with the holding of the United States Claims Court in Landmark inc. v. United States, 25 Cl. Ct.100 (1992) [92-1 USTC), AOD Acquiescence, May 5, 1997.

  3. Patronage and nonpatronage losses must be computed separately and carried over or carried back separately. This is shown on Form 8817, which is filed with the tax return (for all cooperatives with gross receipts of $10,000,000 or more).

Netting of Patronage Gains and Losses
  1. IRC section 1388(j) provides special rules for the netting of gains and losses by all exempt and nonexempt cooperatives. In general, IRC section 1388(j) permits cooperatives to offset patronage losses (including patronage losses carried over into the taxable year) that are attributable to one or more allocation units (such as a function, division, department, geographic unit, etc.) against patronage earnings of one or more other allocation units. However, the cooperative must provide the affected patrons with notice that the cooperative is netting losses against gains. Additionally, netting of losses against gains is not permissible to the extent it reduces nonpatronage earnings. See Farm Service Cooperative v. Commissioner, 619 F.2d 718 (8th Cir. 1980).

Overview of Tax Returns

  1. farmers' cooperatives, and any other corporations filing as cooperatives under subchapter T of the Internal Revenue Code, are required to file timely tax and information returns.

Income Tax Returns
  1. Form 990-C is filed by farmers' cooperatives (exempt or taxable), and Form 1120 is filed by other corporations filing as a cooperative under IRC section 6072(d). Both types of returns are due on or before September 15 for calendar years, or the 15th day of the ninth month following the close of the taxable year.

  2. Farmers' cooperatives (whether exempt or taxable) and other taxable cooperatives are subject to subchapter T, provided the cooperative is under an obligation to pay patronage dividends equal to at least 50-percent of its net earnings from patronage, or actually paid such dividends in such amount for the most recent taxable year in which it had net earnings from patronage. See IRC section 6072(d).

  3. A taxable cooperative that does not satisfy IRM 4.44.1.9.7.1(2) is required to file its tax return by the 15th day of the third month after the close of its taxable year, like any other corporation.

  4. Nonexempt cooperatives with gross receipts of $10 million dollars or more must file Form 8817, Allocation of Patronage and Nonpatronage Income and Deductions, with their tax return, if they have both patronage and nonpatronage income. Many cooperatives do not file schedules attached to the returns and the examiner cannot determine patronage and nonpatronage income and expenses by reviewing the returns. The examiner will need to ask for the allocation schedules.

  5. For the purpose of determining whether the 50-percent requirement is met, net earnings are not reduced by any taxes imposed by subtitle A of the Internal Revenue Code nor by dividends paid on capital stock or other proprietary interest. A cooperative can pay less than 50-percent patronage dividends and still file under IRC section 6072(d). The bylaws must "obligate" the cooperative to pay patronage dividends of at least 50-percent of its net earnings from patronage. See Revenue Ruling 93-21.

Information Returns
  1. In general, all subchapter T cooperatives making payments of patronage dividends and other payments described in IRC section 1382 aggregating $10 or more per person must file information returns on Forms 1096 and 1099. See IRC section 6044 and the implementing regulations for further detail.

Digests of Published Rulings and Procedures

  1. Following is a list of published rulings that are categorized between:

    1. Nonexempt cooperatives, and

    2. Miscellaneous cooperatives meeting the requirements of subchapter T of the Internal Revenue Code.

Nonexempt Cooperatives
  1. Cooperatives; farmers; 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.

  2. Net operating loss deduction—The net operating loss deduction allowed under IRC section 172(a) does not reduce the earnings of a cooperative that are available for payment of patronage dividends. Revenue Ruling 65-106.

  3. Assignment to distributing cooperative—Patronage dividends in the form of written notices of allocation are deductible in computing the taxable income of a cooperative where the cooperative pays more than 20-percent of such dividends by qualified check, even though the patron has specifically assigned 100-percent of his/her annual allocable patronage dividend to the cooperative to be credited against annual payments due under the terms of a conditional sales contract. Revenue Ruling 65-128.

  4. Assignment for membership dues owed to farmers' educational organization—Amounts paid in cash or by check out of current patronage dividends by a cooperative for membership dues owed to a farmers' educational organization by the cooperative’s member/patrons will be treated as patronage dividends "paid in money" provided that the payments are made at the option of the member for whom the dues are paid. Revenue Ruling 65-221.

  5. Withholding; nonresident aliens—A domestic cooperative is required to withhold tax on patronage dividends distributed to its nonresident member patrons, some of whom are nonresident aliens, and foreign corporations, or foreign cooperatives not doing business in the U.S., since these dividends are amounts which are fixed or determinable annual or periodical income from sources within the U.S. Revenue Ruling 66-53.

  6. Subchapter T cooperative; financing corporation—A financing corporation which purchases accounts receivable with recourse from its member stores at face value charging a uniform discount rate to all members and distributes any net savings to its members on a cooperative basis is an organization described in IRC section 1381(a). Cash distributions made to the member/patrons by the corporation which are based on the discounts charged each member as compared with the discounts charged all members are patronage dividends and deductible from the corporation’s gross income under IRC section 1382. Revenue Ruling 66-98.

  7. Producer/patron-purchaser of crops—A producer/patron of a nonexempt marketing and purchasing cooperative who purchases crops marketed by the cooperative for other producer/patrons is not dealing with the cooperative "on a cooperative basis" and, therefore, is not a "patron" with respect to such purchases. Such a producer/patron/purchaser is in the same position as a commercial customer of the cooperative, and the cooperative is not entitled to a deduction for so-called patronage dividends paid on such purchases. Distinguished by Revenue Ruling 72-547 to provide in certain cases that a nonexempt cooperative may deduct patronage dividends paid to both marketing and purchasing patrons of the same grain. Revenue Ruling 66-380.

  8. Cooperative operating on pooling basis—Only those payments from each pool which are paid by a cooperative to its patrons and which are determined with reference to the net earnings of the cooperative with respect to such pool or pools are patronage dividends. These amount are determinable only in the taxable year in which each pool closes. Amounts set up on the books of an accrual method cooperative at the close of each taxable year as amounts due patrons, which are determined by estimating the sales proceeds of the patrons’ crops in pools yet to be closed, are neither deductible by the cooperative nor includible in the patrons’ gross income. Modified to provide that inventories of unmarketed commodities on hand at the end of the year should be valued at cost. Clarified to provide that a "completed pool" accounting method is not an acceptable method. Revenue Rulings 67-333, 69-67 and 69-71.

  9. Earnings from nonmember business—Distributions of earnings from business attributable to nonmembers by a nonexempt farmers' cooperative to its members in accordance with its by-laws do not qualify as patronage dividends and, therefore, are not deductible in arriving at taxable income. A.R.R. 6967 superseded. Modified by Revenue Ruling 72-602. Revenue Ruling 68–228.

  10. Per-unit retain allocations—Guidance is provided for cooperative organizations, including farmers' cooperatives, and their patrons in their treatment of per-unit retain allocations made during taxable years of cooperatives beginning after April 30, 1966, with respect to products delivered in such years. Revenue Ruling 68-236.

  11. Farmers; nonpatronage income reported on installment method—An exempt farmers' cooperative that realized nonpatronage income upon the sale of a building, and elected to report the gain under the installment method of accounting, may deduct the portion of the gain included in its income in each taxable year under the installment method, provided it allocates and pays such amount on a patronage basis, insofar as is practicable, to the persons who were patrons during the taxable years in which the asset was owned by the cooperative. Revenue Ruling 68-332.

  12. Farmers; unclaimed nonpatronage income paid to State—Unclaimed allocations of nonpatronage income paid to a State by an exempt farmers' cooperative pursuant to the State’s escheat law are deductible by the cooperative to the extent such amounts would have been deductible had they been paid to the patron. The cooperative must file information returns indicating payments are made to the State on behalf of the patrons. Revenue Ruling 68-423.

  13. Farmers' cooperative; pooling arrangement; unmarketed commodities—Inventories of unmarketed commodities on hand at the end of the taxable year of a farmers' marketing cooperative operating under a pooling arrangement should be valued at cost. For this purpose cost is the sum of the advances paid to its patrons plus the processing or handling expenses actually paid or incurred. Revenue Ruling 67-333 modified. Revenue Ruling 69-67. (Some court cases may differ on cost basis depending on facts and circumstances.)

  14. Taxable income of cooperatives; products marketed under pooling arrangements—A "completed pool" method of accounting employed by a farmers' cooperative operating under a pooling arrangement is not an acceptable accounting method for income tax purposes. Revenue Ruling 67-333 clarified. Revenue Ruling 69-71.

  15. Subsidiary of wholesale grocery cooperative—A wholesale grocery cooperative is entitled to a deduction for patronage dividends paid its independently operated wholly owned subsidiary where it deals with the subsidiary on a cooperative basis in the same manner as with its other retail grocer members. Revenue Ruling 69-389.

  16. Allocation; amounts received from cooperative bank—The amount received by a nonexempt farmers' cooperative on a patronage basis, from a bank for a cooperative which is subsequently allocated and paid by the farmers’ cooperative to its own patrons qualifies as a patronage dividend. If the income is produced by a transaction which actually facilitates the accomplishment of the cooperative's marketing, purchasing or service activities, the income is from patronage sources. Revenue Ruling 69-576.

  17. Net profits to patrons—The amount of a cooperative’s net profits distributed to its patrons on a patronage basis in excess of dividends paid on its stock during the taxable year qualifies as patronage dividend. Such amount is deductible by the cooperative if it otherwise meets the requirements with respect to form and timing. Revenue Ruling 69-621.

  18. Farmers; handling and storage charges under "reseal" program—Handling and storage charges paid to a farmers' cooperative by the Commodity Credit Corporation under the "reseal" program of the U.S. Department of Agriculture is income of the cooperative derived from business done with or for the U.S. or any of its agencies and is not income from patronage sources. Revenue Ruling 70-25.

  19. Farmers; notices of allocation; redemption—Losses incurred by members of an agricultural cooperative upon the redemption by the cooperative of its qualified written notices of allocation for less than the stated face amount are ordinary losses deductible in the year of redemption measured by the difference between the stated amount included in income in the year of issuance and the amount received upon redemption. Revenue Ruling 70-64.

  20. Farmers; dividends paid; taxable year of deduction—A farmers' cooperative is entitled to a deduction for dividends paid on its capital stock in the year it was held to be exempt even though the dividend was declared in the prior year when it was operating as a nonexempt cooperative. Revenue Ruling 70-233.

  21. Per-unit retain certificates; transaction between cooperatives—IRC section 1382(f) applies to a transaction in which a cooperative receives qualified unit-retain certificates in a subsequent taxable year for seed purchased from its patrons and delivered to another cooperative of which it is a patron. Revenue Ruling 70-249.

  22. Farmers; cancellation of patron’s marketing credits—Patrons notified in writing by a farmers' cooperative that their outstanding marketing credits which they had previously included in gross income had been cancelled to offset the excessive marketing advances paid them in a prior year are entitled to an ordinary loss for the year in which notified. Revenue Ruling 70-407.

  23. Service corporation—A corporation rendering services to its members through a clearing house to effect settlement of orders between them and providing extensive advertising, public relations, and educational and research services at cost and making distributions to the members based on business transacted with them, is "operating on a cooperative basis" and the distributions are patronage dividends. Revenue Ruling 70-481.

  24. Per-unit retain certificates; redemption date—Per-unit retain certificates, issued before October 10, 1969, by an accrual basis cooperative and not redeemed within 30 days of issuance are treated as qualified certificates under IRC section 1388(h). Per-unit retain certificates redeemed on the date of issuance or within 30 days of issuance are treated as cash advances. Revenue Ruling 71-374.

  25. Farmers; advances to member growers—Advances received by cash method member growers from a cooperative association for crops sold to the association, under an agreement whereby all crops are sold to the association for resale, are partial payments includible in the growers’ gross income in the year received. The growers may not defer the accounting for the payments until the year in which final settlement is made for their crops. I.T. 2107 superseded. Revenue Ruling 71-430.

  26. Distribution based on man-hours worked—Distributions of net earnings by a nonexempt cooperative association to its member-stockholders based on man-hours worked by such members qualify as patronage dividends deductible from gross income of the association. Gain recognized by the cooperative pursuant to an election under IRC section 631 (a) to treat the cutting of timber as a sale or exchange is patronage income. Revenue Ruling 61-47 revoked. Revenue Ruling 71-439.

  27. Federal intermediate credit bank; class B stock—The tax treatment of patronage dividends received by a production credit association (PCA) from a Federal intermediate credit bank (FICB), a cooperative exempt under section 501(c)(1) of the Internal Revenue Code, in the form of the bank’s class B stock is determined under the provisions of Regs. 1.61-5 and not subchapter T (IRC sections 1381-1388). The class B stock is includible in the PCA’s gross income at its fair market value for the year of receipt. Revenue Ruling 71-556.

  28. Federal intermediate credit bank; written notification—The tax treatment of a patronage dividend received by a production credit association (PCA) from a Federal intermediate credit bank (FICB) in the form of the bank’s written notification of reserve allocations is determined under the rules of Regs. 1.61-5 and not subchapter T (IRC section 1381-1388). No portion of such reserve allocation is includible in gross income in the year of receipt unless a fair market value is clearly established. However, any amount realized on a subsequent redemption or other disposition is includible in ordinary income in the year of redemption or disposition. Revenue Ruling 71-557.

  29. Federal intermediate credit bank; participation certificate; commercial bank—The tax treatment of patronage dividends received by a commercial bank from a Federal intermediate credit bank (FICB), a cooperative organization exempt under IRC section 501(c)(1), in the form of participation certificates, is determined under the provisions of Treas. Reg. 1.61-5 and not subchapter T. Revenue Ruling 71-558.

  30. Purchasing and marketing patrons of grain—A nonexempt marketing and purchasing cooperative operates a purchasing function in which it processes grain for livestock feed and operates a marketing function, one department of which markets grain for the grain farmers and also supplies some grain to livestock farmers as feeder grain. These combined marketing and purchasing activities do not preclude the deduction of patronage dividends paid to both marketing and purchasing patrons of the same grain. Revenue Ruling 66-380 distinguished. Revenue Ruling 72-547.

  31. Majority nonmembers; nonexempt cooperative—A nonexempt cooperative doing more than 50-percent in value of its business with members may qualify for the benefits of Subchapter T even though the number of nonmembers is greater than the number of members. Revenue Ruling 68-228 modified. Revenue Rulings 72-602 and 93-21.

  32. Cooperative; 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 the deceased member’s lifetime had filed a consent pursuant to IRC section 1388, for business conducted with the cooperative prior to the member’s 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.

  33. Bank for Cooperatives; nonexempt; interest earned; distribution—Interest income earned by a nonexempt Bank for Cooperatives from investments in Government securities and from surplus funds loaned to other farm credit banks is nonpatronage income and is not deductible as a patronage dividend even if distributed to member-patrons. Revenue Ruling 73-497.

  34. Distribution based on man-hours worked; method of computation —Distributions of a nonexempt cooperative, whose work force is composed of both member and nonmember workers, based on the total hours worked by the nonmember workers plus the total hours worked by member workers increased by a specified percentage to determine the applicable percentage of net income available for patronage distributions, do not qualify as patronage dividends to the extent that such distributions are from income attributable to nonmember workers and to the extent the cooperative is not entitled to a deduction for such distributions. The quantity method to determine patronage dividends may be elected and an example of the calculations under this method is set forth. Revenue Ruling 74-20.

  35. Distribution based on man-hours worked—Gain recognized by a nonexempt cooperative engaged in the manufacture of wood products under an election to treat the cutting of timber as a sale or exchange is patronage income in the year recognized to the extent attributable to member workers and will qualify for distribution as a patronage dividend. That portion of the gain attributable to nonmember workers is not patronage income and will not qualify. Revenue Ruling 71-439 amplified. Revenue Ruling 74-24.

  36. Nonexempt cooperative—The ordinary income portion of gain realized from the sale of IRC section 1245 property by a nonexempt cooperative is patronage sourced income to be allocated between member and nonmember workers in accordance with the applicable method of allocation utilized in those prior years in which depreciation deductions were taken on the property sold and to the extent allocated to member workers qualifies as a patronage dividend. However, the portion of such gain attributable to depreciation deducted in years the cooperative did not qualify under IRC section 1381(a) and the portion of the gain treated under IRC section 1231 as gain from the sale of a capital asset are not patronage income. Revenue Ruling 74-84, .

  37. Nonexempt cooperative; source of income or loss—Interest income received by a nonexempt cooperative from loans made to its chief supplier to assure supplies, and an operating loss sustained in its operation of a veneer plant operated as a part of its business, are patronage sourced to the extent allocable to member workers. However, a payment it received as lessee from the cancellation of its lease on the veneer plant is nonpatronage sourced income. Revenue Ruling 74-160.

  38. Nonexempt cooperative; State taxes on earnings from nonmember business—The state income taxes paid by a nonexempt farmers' cooperative on earnings from business done with nonmembers does not reduce the earnings from business done with members in computing the amount available for distribution as a patronage dividend. Revenue Ruling 74-161.

  39. Distribution in excess of net earnings from patrons’ business—A distribution by a nonexempt cooperative that used different methods of depreciation for net book earnings and net earnings from business done with or for patrons reported for Federal income tax purposes will qualify as a patronage dividend only to the extent of the net earnings reported for Federal income tax purposes. Revenue Ruling 74-274.

  40. Investment credit; qualified investment—An example illustrates that in the computation of the amount of a qualified investment for purposes of the investment credit a cooperative’s "taxable income" for purposes of the ratio provided by IRC section 46(d)(2)(C) must reflect deductions allowed under IRC section 1382(b) and special deductions allowed under IRC section 243. Revenue Ruling 74-288.

  41. Earnings computation; depreciation—A subchapter T Cooperative may use any method of depreciation provided under IRC section 167(b), subject to limitations of IRC section 167(c) and 167(j), in computing its depreciation deduction under IRC section 167(a), but the method used must also be used for determining the amount of its net earnings for computing patronage dividends. Revenue Ruling 74-303.

  42. Farmers; nonqualifying patronage dividends—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.

  43. Net operating loss; patronage dividend deduction; loss in nonmember transactions—For a nonexempt cooperative that has a preexisting obligation to pay patronage dividends to members, but does not pay patronage dividends to nonmembers, and then sustains a net loss in nonmember transactions in a taxable year, the amount available for distribution as patronage dividends is its net earnings from member business undiminished by the net loss; the loss may be applied against nonmember income in accordance with IRC section 172. Revenue Ruling 70–420 revoked. Revenue Ruling 74-377.

  44. Purchasing and feed yard patrons; 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, 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, 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.

  45. Farmers; distribution received from subsidiary DISC—The dividend an exempt farmers' cooperative received from its wholly owned DISC out of the DISC’s commission income earned on its overseas sales of the cooperative patron's products is patronage sourced income and not taxable to the cooperative if distributed in the form of qualified patronage dividends. Revenue Ruling 75-228.

  46. Cooperative; change in accounting method—A nonexempt cooperative changed from LIFO to FIFO for inventory purposes, which required a positive adjustment to income under IRC section 481(a). Held: 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 IRC section 1382(f) purposes. Revenue Ruling 79-45.

  47. Cooperative; integrated poultry operation—A nonexempt cooperative engaged in an integrated poultry operation that is indistinguishable from the normal operation of a corporation doing business for profit is not operating on a cooperative basis within the meaning of IRC section 1381(a)(2) and is subject to tax at the corporate level on amounts returned to its shareholder-members according to their marketing agreement, Revenue Ruling 82-51.

  48. A cooperative that operates on a for-profit, nonpatronage basis with nonmembers will not be precluded from being considered "operating on a cooperative basis" simply because it does less than 50-percent in value of its business with members on a patronage basis. The cooperative principles stated in Puget Sound Plywood, Inc., 44 TC 305, provide the basis for determining whether a corporation is operating on a cooperative basis under IRC section 1381(a)(2). Revenue Ruling 93-21.

Miscellaneous
  1. Deposits made by borrower-stockholders—The taxpayer, a lending corporation, was organized by five members of a wholesale purchasing cooperative. A refundable deposit of five cents per box of fruit sold by the borrower-stockholder was required to indemnify the taxpayer against credit and operating losses. The deposits remained the property of the borrowers until such time as the taxpayer might elect to use them for a purpose specified in the loan agreements, and were not intended as compensation to the taxpayer for use of its capital. Held, the deposits were not taxable income to the taxpayer when received. Growers Credit Corp., 33 T.C. 981, (1960), Acq., 1960-2 C.B. 5.

  2. Farmers; Class C stock of "Bank for Cooperatives" ; interest v. capital asset—Class C stock of a Bank for Cooperatives purchased quarterly by a farmers’ cooperative association as a condition of obtaining a loan from the Bank is a capital asset and its cost is not deductible as an interest expense. Mississippi Chemical Corp., 405 U.S. 298, (1972), 1972-1 C.B. 229.

  3. Landlord as agent for sharecropper—The taxpayer farmers’ cooperative association contracted with certain landlords to gin the cotton and sell the cotton seed grown on their lands by sharecroppers. The contracts were negotiated solely with the landlords, although they provided that the latter were also acting as agents for the sharecroppers. The taxpayer paid the landlords dividends attributable to the sharecroppers’ share of the cotton. Held, these dividends were patronage dividends properly excludable from the taxpayer’s gross income. Producers Gin Assn., 33 T.C. 608; (1959), Acq., 1960-2 C.B.6.

  4. Distribution based on man-hours worked—Amounts distributed during 1958, 1959, and 1960, pursuant to a preexisting legal obligation, as patronage dividends by a nonexempt workers’ cooperative association to its worker/members in proportion to the hours worked in producing and marketing the products of their cooperative endeavor, are excludable from the gross income of the cooperative association. Puget Sound Plywood, 44 T.C. 305, (1965), Acq., 1966-1 C.B. 3.

  5. Allocations in document form; treatment in the hands of patrons—Amounts were retained out of earnings of a farmers’ cooperative, at the sole discretion of the board of directors, for capital purposes. The amounts were evidenced by revolving fund certificates issued to members in payment of patronage dividends. The certificates bore no interest, were retirable at the sole discretion of the directors, were subordinate to all other debts of the cooperative, and had no fair market value when issued. Held, the certificates were not income to members of the cooperative in the year issued. B.A. Carpenter, 20 T.C. 603, Acq., 1958-2 C.B. 4.

  6. The discounted value of qualified notices of allocation paid to patrons who terminated their membership in the cooperative did not have to be included in the cooperative's gross income. The tax benefit rule did not apply as the tax court had determined. The cooperative's payments did not cease to be deductible as patronage dividends when the cooperative redeemed the qualified written notices for less than their stated amounts and reclassified the difference on its financial statement as additions to its retained earnings. See Gold Kist Inc., Petitioner-Appellant, v. Commissioner of Internal Revenue, Respondent-Appellee, No. 96-8257, United States Court of Appeals, for the Eleventh Circuit, 110 F. 3d 769: 1997. The Service has not acquiesced to the court's ruling.

  7. Federal intermediate credit bank; class B stock; interest paid-Patronage dividends received by a production credit association (PCA) from a Federal intermediate credit bank (FICB) in the form of the bank’s class B stock, during the bank’s fiscal year in which it had class A stock outstanding, does not represent income "wholly exempt" within the meaning of IRC section 265(a)(1) and no portion of the deduction for interest paid by the PCA on a loan from the FICB will be disallowed. Revenue Ruling 73-471.

  8. Allocations in document form—When a patron of a farmers’ marketing or purchasing cooperative receives amounts allocated to him/her in document form pursuant to a preexisting contractual obligation, or the dollar value is known to him/her, the face amount is includible in income in the year of receipt and the basis upon redemption, sale, or other disposition, is the face amount. Under certain circumstances where the patron reports less than the face amount of the document in his/her return for the year of receipt his/her basis is limited to the amount reported. Revenue Ruling 54-10.

  9. Liquidation; value of capital stock—Where an exempt growers’ marketing cooperative association, pursuant to a revolving fund agreement, each year retains portions of the amounts due growers for crops and issues stock in exchange, and the growers report the face amount of the stock received as part of income from crops each year, the value of the stock does not represent earnings and profits of the association upon its liquidation. Revenue Ruling 54-244.

  10. Allocations in document form; dissolution or insolvency—Where an allocation in document form is made by a cooperative to its patrons, the type of instrument will indicate whether a loss due to worthlessness, upon dissolution or insolvency of the cooperative which issued it, should be treated as a bad debt or a capital loss. Revenue Ruling 55-66.

  11. Distribution by nonexempt cooperative—Patronage dividend distributions made by a nonexempt farmers’ cooperative to its members who owned the crop at the time it was delivered to the cooperative are excludable from the cooperative’s income if made in accordance with a preexisting agreement. However, any dividends attributable to sales of products made to nonmembers are taxable to the cooperative and to its members. Revenue Ruling 57-59.

  12. Farmers; overplus held by Commodity Credit Corporation—A farmers’ cooperative does not have a claim of right to any part of the one-half of the "overplus" held as collateral security retained by the Commodity Credit Corporation from the sale of a crop until the excess over the outstanding indebtedness can be determined. Such amount constitutes gross income to the cooperative in the year received. Revenue Ruling 57-358.

  13. Farmers; certificates of interest for stock; reorganization—5-percent cumulative preferred capital certificates of interest of a farmers’ cooperative association received by shareholders of a corporation merged under state law into the association represent, under described facts, equity interests in the association. No gain or loss will be recognized to the shareholders of the acquired corporation. Revenue Ruling 68-22.

  14. Farmers; reorganization; revolving fund credits for capital stock—The rearrangement of the capital structure of a tax-exempt, farmers’ marketing cooperative whereby its members exchange revolving fund credits for share interests in a permanent capital fund constitutes a recapitalization and therefore, a reorganization within the meaning of IRC section 368(a)(1)(E). Revenue Ruling 70-298.

  15. Investment credit; carryback and carryovers—A cooperative association that acquired and placed in service IRC section 38 property during a taxable year in which its operations resulted in a net operating loss, has no qualified investment in IRC section 38 property for that year and, therefore, has no unused investment credit for carryback or carryover purposes. Revenue Ruling 70-328.

  16. Cooperatives; change in accounting method—A mandatory procedure is provided for taxpayers to change their method of accounting for interest on indebtedness when they have been reporting interest income or deductions in accordance with the Rule of 78’s computation. This procedure applies to loans for which the interest computed using the Rule of 78’s does not exceed the loan payments during any year of the term of the loan. Revenue Procedure 84-27.

  17. Cooperatives; change in accounting method—A mandatory procedure is provided for taxpayers to change their method of accounting for interest on indebtedness when they have been reporting interest income or deductions in accordance with the Rule of 78’s computation. This procedure applies to loans for which the interest computed using the Rule of 78’s exceeds the loan payments during any year of the term of the loan. Revenue Procedure 84-28.

  18. Cooperatives; change in accounting method—A procedure is provided for taxpayers to change their method of accounting for interest on indebtedness when they have been reporting interest income or deductions in accordance with the Rule of 78’s computation. This procedure applies to short-term consumer loans that are covered by the administrative exception of Revenue Procedure 83-40. Revenue Procedure 84-302.