Section of Taxation Publications
  VOL. 56
NO. 4
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
 What Then To Do With a Non-Cooperative Cooperative?
Clayton S. Reynolds*

*Partner, Orrick, Herrington & Sutcliffe LLP, New York, New York; Trinity College, Cambridge Univ., B.A. 1976; Harvard Law School, J.D. 1979; New York Univ. School of Law, LL.M. 1987.


This article examines the tax treatment that should be accorded an entity that, while cooperative in form, is not operating "in accordance with cooperative principles." More particularly, this article seeks to determine whether such an entity may deduct (or exclude) patronage allocations that it makes to its patrons notwithstanding that the entity is excluded from the benefits of Subchapter T of the Code.

In this regard, a cooperative is an atypical form of business organization. While cooperatives come in many flavors, most can be categorized as either supply or marketing cooperatives. As their names suggest, a supply cooperative is organized to provide supplies to the cooperative's patrons, while a marketing cooperative is organized to market the products of the cooperative's patrons. Unlike a regular corporation, whose raison d'être is to earn a profit for the corporation's shareholders, a supply or marketing cooperative's overriding purpose is to provide the best price that it can with respect to the products supplied to or marketed on behalf of the cooperative's patrons (which may or may not be members of the cooperative). As a result, many cooperatives have no capital stock, and those that do invariably limit the amount of dividends payable with respect to such stock. Hence, all or most of the earnings of a cooperative redound to the benefit of the cooperative's patrons. Mechanically, this is typically accomplished by having the cooperative allocate its earnings (or margins, as they are normally called) each year to its patrons based on the level of business each patron has conducted with the cooperative during that year (usually referred to as a patronage dividend). While cooperative margins are allocated on an annual basis, the actual payment of the allocated amounts may occur many years subsequent to the year in which (or, more precisely, for which) they are allocated, depending on the cooperative's "rotation cycle."

With important exceptions, Subchapter T sets forth the rules that are applicable to the taxation of cooperatives and their patrons. The most important benefit accorded cooperatives under Subchapter T is the ability, under certain circumstances, to deduct patronage dividends paid to the patrons of the cooperative (hereinafter, the "statutory patronage deduction"). This deduction did not originate with Subchapter T, however. Thus, as far back as the 1920's, cooperatives were allowed to deduct (or exclude) allocations of patronage-sourced earnings made to their patrons in the year the margins were allocated (hereinafter, the "common law patronage deduction").

The primary purpose underlying Subchapter T, which was enacted in 1962, was Congressional and Service dissatisfaction with various judicial decisions that had sanctioned the failure by cooperative patrons to account for patronage allocations in the same year as the cooperative making the allocations was allowed the common law patronage deduction. Initially, the Service reacted to these pro-patron decisions by attempting to deny and/or defer the common law patronage deduction, but the courts concluded that the deduction was too enshrined in the law to be overruled by administrative fiat. Hence, the Service was confronted with the problem of homeless income-that is, with income which the allocating cooperative was permitted to deduct in the year the income was earned and allocated, but which the patron receiving the allocation was not required to account for until such time as the income was actually paid. This inconsistency was particularly galling because the rationale underlying the common law patronage deduction, as discussed below, was inconsistent with the rationale permitting the deferral of income at the patron level. Hence, the primary effect and purpose of Subchapter T was to mirror the timing of the patronage deduction with that of the patronage income inclusion.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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