Simple Idea, Complex Rules Cooperatives Have Their Own Unique Set Of Taxation Rules
Understanding and interpreting the IRS's Tax Code is rocket science as well as an art form; it keeps a small army of tax attorneys, accounts and court system occupied and well-paid.
Cooperative taxation is no exception; it is complicated and has specialized rules and exceptions. The following is a brief overview of general tax principles for cooperatives, based largely on information provided by the National Cooperative Business Association, which presents all types of co-ops. It is not comprehensive; to get a full understanding of cooperative taxation, consult with a tax attorney or CPA with cooperative taxation experience.
Credit unions are financial cooperatives exempt from federal taxes under the Internal Revenue Tax Code and most state taxes because they are member-owned, democratically operated not-for-profit organizations. It is the cooperative structure that justifies the tax exemption. The size, services or serving people of modest means is irrelevant to the tax exemption, even though the latter is one of the missions of credit unions.
Different Co-Ops, Same Principle
Other cooperatives are covered under different provisions of the Internal Revenue Code, but like CUs, they have a unique tax status based on the same principle-member-owned, democratically operated and income may be distributed as patronage dividends. In most cases, cooperatives do not have taxable income because they pass the income along to members in the form of lower prices or patronage refunds. If cooperatives pay taxes on income, it is income from business that isn't derived from members or was not distributed to members.
There are some 21,000 cooperatives in the United States serving 120-million members. The source of capital for cooperatives is the membership-either from direct investment or retained earnings.
Credit unions are consumer cooperatives similar to rural electric, telephone and health care cooperatives. Credit unions have similar exemptions; they are not taxed on income derived from doing business with members. Business done with members of cooperatives is done at cost. The cooperative provides services or products, such as credit or electricity at cost. The surplus is used for services to members or given to members as a patronage refund. There are no profits. The surplus goes back to the member.
Four Categories Of Cooperatives
There are four main categories of cooperatives: producer-owned, consumer-owned, purchasing and shared services, and worker-owned. Each of these cooperative entities may have slightly different tax treatment. In certain circumstances, some of the individual cooperatives can be subject to taxation of net income. The general tax principles of cooperatives for the most part are:
* Single tax principle: surplus member revenues not taxable. Cooperatives do not pay income taxes for surplus revenues generated by member business and distributed to or used in the service of members.
* Treatment of non-member revenue. Cooperatives pay income tax on non-member surplus revenues. This is the same tax treatment as any other type of corporation. Some cooperatives, such as credit unions, serve only members, so they have little or no non-member income. Generally any income derived from activities for which the principle purpose is serving members is not taxable.
* Tax treatment of patronage refunds. Cooperatives with surplus member revenue-net income-have a number of options available to them. The cooperative may chose to retain the net income and may in certain circumstance be subject to federal taxes on that net income retained. Another option for the cooperative is to distribute the net income to individual members in the form of patronage dividends. In the case of patronage dividends, the federal government may consider that distribution as a non-taxable event and that distribution allows the cooperative to avoid paying tax on the amount distributed.
In some instances, members must pay tax on the patronage dividends they receive.