Handling net margins under federal tax laws


Material Information

Handling net margins under federal tax laws
Series Title:
FCS information ; 39
Physical Description:
6 p. : ; 23 x 10 cm.
United States -- Farmer Cooperative Service
U.S. Department of Agriculture, Farmer Cooperative Service
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Publication Date:


Subjects / Keywords:
Agriculture, Cooperative -- Taxation   ( lcsh )
Agricultural cooperative credit associations   ( lcsh )
federal government publication   ( marcgt )
non-fiction   ( marcgt )


Statement of Responsibility:
U.S. Department of Agriculture, Farmer Cooperative Service.
General Note:
General Note:
Revised September 1976.
General Note:
Cover title.

Record Information

Source Institution:
University of Florida
Rights Management:
All applicable rights reserved by the source institution and holding location.
Resource Identifier:
aleph - 020453934
oclc - 02582930
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Full Text
9 3 J.S : 3,/rej,

Net Margins
Tax Laws

FCS Information 39
U.S. Department
of Agriculture




Section 17 of the Revenue Act of 1962,
approved October 16, 1962, and amended in 1966
and 1969, added a new Subchapter T to the
Internal Revenue Code of 1954.2 It applies to all
farmer cooperatives and certain other cor-
porations operating on a cooperative basis. It is
effective in taxable years that begin after Decem-
ber 31, 1962.
The law preserves the principle of a single,
current tax on income produced through farmer
cooperatives, provided they meet these condi-
1. Adhere to certain requirements as to
the form in which they distribute patronage
2. Make the distributions within the pre-
scribed time.
In the process of conforming with the law,
however, a number of alternatives are available
that must be evaluated and on which decisions
must be made. These are as follows:

Choice 1
A major alternative a farmer cooperative
faces is whether to operate in compliance with
the requirements of Section 521 of the Internal
Revenue Act of 1954 as a so-called "income tax
exempt" association; or whether to operate as a
nonexempt organization by not meeting the
requirements of Section 521. The changes made
by Section 17 do not repeal or modify in any

'This publication was originally prepared by Ray-
mond J. Mischler, now deceased, who at the time was an
attorney in the Office of the General Counsel. It has been
reviewed and revised by David Volkin, Senior Agricultural
Economist and J. Warren Mather, Assistant Administrator,
Farmer Cooperative Service.
2See Section 211, Foreign Investors Tax Act of 1966,
Pub. L. 89-809, approved November 13, 1966.

way the requirements of Section 521 of the
Internal Revenue Code of 1954 relating to qual-
ification for a letter of exemption. Such a letter
entitles an eligible farmer cooperative to two spe-
cial deductions:
1. Amounts paid as dividends during the
taxable year on capital stock (which has been
construed to include any form of return on all
genuine capital interests); and
2. Amounts of nonpatronage income (such
as income on business with the United States,
rents, and interest) paid out on a patronage
basis, if distributed within 8V months after the
year in which it was derived.

Choice 2
The next choice or alternative is whether
to comply with the precise rules set forth in Sub-
chapter T of the 1954 Code pertaining to the
form and time of payment of patronage refunds
that will allow the cooperative to use such
refunds to reduce its gross income for tax pur-
poses. For, to emphasize, it is the form and tim-
ing of the refunds that determine their tax treat-
ment under the law, at both the cooperative level
and, in the main, at the patron level.
The law lays down precise rules on the
circumstances under which farmer cooperatives
(both "exempt" and nonexempt) may use
patronage refunds to reduce their gross income
for tax purposes. They are:
First-The refund must meet the defini-
tion of a "patronage dividend" set forth in the
statute. This means that the refund must be:
1. Computed on the basis of quantity or
value of business done with or for the patron;
2. Made pursuant to a pre-existing written
obligation of the cooperative; and
3. Determined by reference to the net
earnings of the organization from business done
with or for patrons. (This excludes true "capital
retains" from sales proceeds.)

In 1966, however, the law was amended to
provide similar treatment for capital retains. In
general, these are amounts allocated to patrons
as evidence of capital they furnish on the basis of
the dollar value or physical volume of products
marketed through the cooperative. The amounts
so allocated are invested without reference to the
cooperative's "net earnings."
Second-The refund or per-unit retain
allocation must be paid in cash, property of a
kind on which a current value can be placed, or
in what the statute calls "qualified written notices
of allocation," or in the case of capital retains,
"qualified per-unit retain certificates."
Third-The refund must be "paid" within
81/ months following the close of the cooper-
ative's fiscal year. (The statute calls the 12-month
fiscal. year plus this 8 months period the coop-
erative's "payment period.")
If the cooperative does not comply with
these rules, it could not exclude patronage
refunds from taxable income and thus would be
subject to taxation on them at the corporate rate.

Choice 3

A third area of choice is whether to use
"qualified written notices of allocation." In all
cases, these allocations to be "qualified" must
meet the following requirements:
1. They must be in the form of a docu-
ment that discloses the amount of the allocation
and the portion thereof that is a patronage divi-
dend (as compared to distributions of non-
patronage income);
2. At least 20 percent of this patronage
dividend must be paid in cash. (No 20 percent
payment is required to "qualify" capital retains).
At this juncture, however, the cooperative
can choose between issuing the paper (1) under
circumstances in which it has a form of patron's
consent, or (2) in a form redeemable in cash by

the patron within a period of 90 days following
the date of issuance.
If the cooperative decides to pay some or
all of its patronage refunds in the form of non-
qualified written notices of allocation, it can do
this simply by failing to comply with one or all
of the requirements as to the form and timing of
the allocation previously discussed. In this event
it incurs a current tax liability. A deduction is
available, however, when the nonqualified allo-
cation is redeemed in cash.

Choice 4

If the cooperative elects to get a form of
patron's consent, it has three available ways to
do this:

1. Individual patron's written consent

This form of consent must be given to the
cooperative before the end of the year in which
the patronage occurs. It applies to all patronage
in that year. It also covers patronage in sub-
sequent taxable years until a written revocation
becomes effective.
A revocation is effective only on
patronage occurring after the close of the cooper-
ative's taxable year in which it is given.

2. Bylaw consent

The patron may consent by obtaining or
retaining membership in a cooperative having
bylaws that require members, as a condition of
membership, to take qualified written notices of
allocation into account currently in computing
their Federal income tax liability.
The bylaw must have been adopted after
October 16, 1962, (November 13, 1966, in the
case of capital retains), and it must clearly set
forth this obligation. The consent under their

method becomes effective only on patronage
occurring after each patron receives a written
notification of the adoption of the bylaw that
explains its significance. A copy of the bylaw
must accompany the notification.
Mailing this material by ordinary mail to
the patron's last-known address is permitted.
New members must have this material before
becoming members. Termination of membership
terminates this form of consent.

3. Consent by qualified check

If neither of the first two methods is
applicable, a patron may consent by endorsing
and cashing a check or other instrument redeem-
able in money that represents at least 20 percent
of the total patronage refund, and has clearly
imprinted on it that endorsing and cashing it will
constitute such consent. (The qualified check
consent does not apply to capital retains.)
This endorsement and cashing must take
place within 90 days following the end of the
cooperative's payment period (see definition pre-
viously given to constitute a valid consent).
This latter method is a "one shot" deal,
applying only to the patronage refund of which
the check is a part.

Choice 5

Under the final regulations (28 Fed.
Req. 3152) a cooperative qualifying under Sec-
tion 521 has two further choices which, if exer-
cised, will not jeopardize its so-called "exempt"
1. It may pay patronage refunds or capital
retains of less than $5 in nonqualified allocations
even to consenting members; or
2. If it issues, to nonconsenting patrons,
nonqualified patronage allocation or nonqualified

per-unit retain certificates, which are interest-
bearing or in the form of dividend-paying stock,
it may make deductions (reasonable in relation to
the fact that it receives no tax benefit on such
allocations until redemption) in the interest or
dividends paid.
The foregoing analysis suggests that there
is a substantial amount of flexibility in the Code
provisions. Farmer cooperatives do, in fact, have
alternative methods of handling net margins
under Federal tax laws. Each cooperative must
determine the courses that will best fit its partic-
ular operations.

Other Publications Available

Federal Income Taxes. Part II-Legal Phases of
Farmer Cooperatives. D. Morrison Neely. FCS
Information 100, 1976. 195 pp.
A Financial Profile of Farmer Cooperatives in
the United States. Nelda Griffin. FCS Research
Report 23. 1970. 95 pp.
Tax Laws Changed on Capital Retains. David
Volkin and D. Morrison Neely. FCS
Reprint 328. 1967. 4 pp.

For copies, write:
Farmer Cooperative Service
U.S. Department of Agriculture
500 12th St., S.W.
Washington, D.C. 20250


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Farmer Cooperative Service provides research, man-
agement, and educational assistance to cooperatives
to strengthen the economic position of farmers and
other rural residents. It works directly with coopera-
tive leaders and Federal and State agencies to
improve organization, leadership, and operation of
cooperatives and to give guidance to further

The Service (1) helps farmers and other rural resi-
dents obtain supplies and services at lower cost and
to get better prices for products they sell; (2) advises
rural residents on developing existing resources
through cooperative action toenhance rural living; (3)
helps cooperatives improve services and operating
efficiency; (4) informs members, directors,
employees, and the public on how cooperatives work
and benefit their members and their communities;
and (5) encourages international cooperative

The Service publishes research and educational
materials and issues Farmer Cooperatives. All
programs and activities are conducted on a nondis-
criminatory basis, without regard to race, creed,
color, sex, or national origin.

Revised September 1976

Information 39

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