%

vehicle registration fees, and excise taxes 

on telephone, power, and other utility services.

Also, no cooperative is exempt from 

Federal income taxation and filing Federal 

income tax forms. Most states with a corporate income tax generally follow the Fed

-

eral rules.

The relationship of cooperative income 

tax treatment to that of other business 

forms is set out in table 1. Of the five com-

mon types of business structures in this 

country, only investor-general corporations 

pay income tax at both the business and 

owner levels. And only 12 percent of Ameri-

can businesses are investor-general corpo-

rations.

Most rules governing cooperative 

income tax treatment are found in sub-

chapter T of the Internal Revenue Code, 

sections 1381-1388. Subchapter T recog-

nizes that the objective of business con-

ducted on a cooperative basis is not to 

generate earnings for the cooperative, but 

to increase the income of the members. 

Thus, net margins on business with or for 

patrons are subject to Federal income tax 

only once, at either the cooperative or the 

Fortunately, the Constitution has endured, 

but so have taxes. Taxes are a factor in the 

planning of every individual and business. 

Like other businesses, cooperatives pay 

taxes. This report is to help persons asso-

ciated with cooperatives (1) understand 

cooperative income tax treatment, (2) avoid 

fundamental mistakes that cost money and 

may lead to an expensive and disruptive 

audit or assessment by the Internal Rev-

enue Service, and (3) use tax planning 

options that may increase the benefits 

members receive from their cooperative.

Cooperatives Are Not Exempt from 

Taxation

Cooperatives usually pay all the special 

taxes levied on businesses. These include 

real and personal property taxes, sales 

taxes, employment taxes (to fund social 

security, unemployment compensation, and 

workers’ compensation benefits), gasoline 

and diesel fuel taxes, license fees, motor 

1

Understanding Cooperatives:

Income Tax Treatment 

of Cooperatives

Cooperative Information Report 45, Section 8

Benjamin Franklin, who among his 

other accomplishments helped 

establish a successful insurance 

cooperative, wrote shortly before his 

own demise, “Our Constitution is in 

actual operation; everything appears 

to promise that it will last; but in this 

world nothing is certain but death 

and taxes.”

United States

Department of

Agriculture

Rural Development

Rural Business

and Cooperative

Service

January 1995

1

TABLE 1—Tax Treatment by Business Type

Business type Times Earnings Level

 Taxed

Proprietorship1 Owner

Partnership1 Owner

Corporations:

Investor-General2 Corporation/Owner

S Corporation1 Owner

Cooperative1 Owner

1

This report does not represent 

official policy of the U.S. Depart-

ment of Agriculture, the Internal 

Revenue Service, the U.S. De-

partment of the Treasury, or any 

other government agency. This 

pulication is presented only to 

provide information to persons 

interested in the tax treatment of 

cooperatives.
user level, but not both. Only this patronage-sourced income is eligible for single 

tax treatment. With certain exceptions, 

income from nonpatronage sources is subject to tax at the cooperative level when 

earned and at the recipient level when paid 

out to members or others. 

This single tax treatment is not limited to 

farmer cooperatives. With certain exceptions, any business that chooses to “operate on a cooperative basis” is eligible for 

tax treatment under Subchapter T.

Patronage Refunds

Single tax treatment is accomplished by 

permitting a cooperative to deduct patronage refunds distributed according to rules 

in Subchapter T. A patronage refund is:

u an amount paid by a cooperative to a 

patron,

u based on the quantity or value of business done with or for the patron, and

u derived from the cooperative’s earnings 

from business done with or for all patrons, 

usually referred to as the cooperative’s 

margins.

For example, if 10 percent of a cooperative’s business is with or for Ms. Jones, and 

the cooperative has a total net margin for 

the year of $1,000, then Ms. Jones receives 

a patronage refund of $100 ($1,000 x 10%).

Payment Options, 

Tax Treatment

A cooperative has three options when distributing patronage refunds—cash, qualified written notices of allocation, and 

nonqualified written notices of allocation. 

Tax treatment is one of the factors to consider in deciding which option(s) to use.

Cash 

A cooperative may pay out some or all of 

its margins to patrons in cash. The cash 

2

portion of a patronage refund is deductible 

by the cooperative in the year the margin 

being returned was earned. It is taxable 

income to the patron in the year received. 

In the example, if Ms. Jones received her 

entire patronage refund in cash, the cooperative would deduct the $100 from taxable 

income for the tax year in which the business occurred that generated the $100 in 

margins. Ms. Jones would include the $100 

in the taxable income of the year in which 

she received the $100 refund.

Written Notices of Allocation

Members usually authorize their cooperative to retain at least a portion of their 

patronage refunds each year as additions 

to equity capital.

To protect single tax status for retained 

margins, the cooperative must, within 

81/2 months after the close of its tax year 

send each patron a written statement 

reporting the amount of that patron’s 

patronage refund for the year. This statement is called a written notice of allocation.

Qualified Notices

Two optional tax treatments are available 

for patronage refunds distributed as written 

notices of allocation. The type of written 

notice of allocation used determines which 

tax treatment applies.

If a cooperative meets the subchapter T 

requirements to “qualify” its written notices 

of allocation, the notice is treated just like a 

cash patronage refund for tax purposes. 

The cooperative deducts the amount allocated from its taxable income in the year 

earned, and the patron includes the entire 

amount in income in the year the notice is 

received.

The requirements to “qualify” a written 

notice of allocation are:

Patron
Notice of

Allocation

u The written notice must be part of a 

patronage refund package of which 20 percent or more is paid in cash, and 

u The patrons must have consented to 

include the face value of the notice in their 

taxable income.

The patron “consent” requirement is satisfied in one of three ways:

u By being a member of a cooperative 

with a bylaw that clearly states membership 

in the cooperative constitutes such consent. The member must receive a copy of 

the bylaw and a written statement of its 

purpose.

u By signing a written consent form before 

the end of the taxable year in which the 

patronage occurs.

u By endorsing and cashing a “qualified 

check.” A qualified check is a specially prepared bank check which, if endorsed and 

cashed, establishes patron consent to 

include the entire refund in taxable income.

Most cooperatives have a bylaw making 

consent automatic with membership. 

Because bylaws only bind members, a 

separate written consent must be obtained 

from nonmember patrons for their consent 

to be effective. Qualified checks are rarely 

used because of the uncertainty over when 

and whether patrons will cash them.

Using the earlier example, if Ms. Jones 

received a qualified written notice of allocation reporting her patronage refund, the 

cooperative could deduct both the amount 

of cash refunded to Ms. Jones (must be at 

least 20 percent of the refund) and the 

noncash portion of her patronage refund in 

the year the underlying margin was earned. 

Ms. Jones must report the entire refund 

($100) as income in the year received, 

even though the cooperative might retain 

up to 80 percent of the funds.

3

Nonqualified Notices

A cooperative may elect not to meet all the 

requirements to qualify a written notice of 

allocation. For example, it might pay less 

than 20 percent of the patronage refund in 

money or it might not have its patrons consent to include the face value of the notice 

in taxable income.

A written notice that for any reason does 

not meet the requisites for qualified status is 

called a “nonqualified written notice of allocation.”

A cooperative that issues nonqualified 

written notices of allocation must include 

the face amount of such notices in its taxable income for the year the covered funds 

are earned and pay tax on these funds at 

regular corporate income tax rates. When 

the cooperative pays out the money represented by the nonqualified notices to the 

patrons (i.e., redeems them), the cooperative can recover the tax paid in the year 

issued, according to formulas established in 

Subchapter T.

The patron receiving a nonqualified 

notice pays no immediate tax on the funds 

it represents. When the cooperative 

redeems a nonqualified notice, the money 

received by the patron is taxable income to 

the patron in the year received.

Again referring to the example, if the 

cooperative issued a nonqualified written 

notice of allocation as a patronage refund 

to Ms. Jones, the cooperative would report 

the $100 face value of the nonqualified 

notice as income in the year it was earned. 

Ms. Jones has no immediate tax liability for 

the refund. When the cooperative pays Ms. 

Jones $100 in money to redeem the nonqualified notice of allocation, the cooperative recovers the tax it paid at the time the 

notice was issued. Ms. Jones reports the 

$100 as income for the tax year in which 

she received the funds.
This circular is one of a continuing series that provides training information and presentations for education 

resource persons who may or may not be familiar with the cooperative form of business. This series provides the 

basic background material they need and in a form that can be readily adapted, with limited preparation time, to a 

lecture or other presentation.

The U.S. Department of Agriculture (USDA) prohibits discrimination in all of its programs and activities on the basis 

of race, color, national origin, age, disability, and where applicable, sex, marital status, familial status, parental 

status, religion, sexual orientation, political beliefs, genetic information, reprisal, or because all or part of an individual's income is derived from any public assistance program. (Not all prohibited bases apply to all programs.) 

Persons with disabilities who require alternative means for communication of program information (Braille, large 

print, audiotape, etc.) should contact USDA's TARGET Center at (202) 720-2600 (voice and TDD).

To file a complaint of discrimination, write to USDA, Assistant Secretary for Civil Rights, Office of the Assistant Secretary for Civil Rights, 1400 Independence Avenue, S.W., Stop 9410, Washington, DC 20250-9410, or call toll-free 

at (866) 632-9992 (English) or (800) 877-8339 (TDD) or (866) 377-8642 (English Federal-relay) or (800) 845-6136 

(Spanish Federal-relay). USDA is an equal opportunity provider and employer. 

If a per-unit retain does not meet the 

requirements for qualified status, the written 

notice is called a “nonqualified” per-unit 

retain certificate. The cooperative includes 

the face value of the certificate in current 

taxable income and recovers the tax paid at 

the time of redemption. The patron does 

not report the retained amount as income 

until the nonqualified certificate is 

redeemed by the cooperative.

Section 521 Cooperatives

Farmer cooperatives meeting certain tests 

set out in section 521 of the Internal Revenue Code may, in addition to patronage 

refunds and per-unit retains, deduct dividends on stock and income from business 

with the United States and other nonpatronage income distributed to patrons on a 

patronage basis.

Filing and Forms

As mentioned earlier, all cooperatives must 

file annual Federal income tax returns, even 

if they have no taxable income.

u Farmer cooperatives file form 990-C.

u Other cooperatives file form 1120.

u Other forms to be filed may include the 

various form 1099’s to report distributions 

paid as interest, stock dividends, patronage 

refunds and per-unit retains (both cash and 

noncash). n

The extent to which a cooperative pays 

its patronage refunds in cash, or in qualified 

or nonqualified written notices of allocation, 

is a matter within the discretion of the board 

of directors. Tax and financial advisers are 

often consulted before the decision is 

made.

Per-Unit Retains

Members of marketing cooperatives have 

an alternative method of providing patronage-based financing. They may authorize 

the cooperative to deduct a portion of the 

proceeds of sale, based on dollar value or 

physical volume of products marketed 

through the cooperative. This method of 

financing is called “per-unit retains.”

Tax treatment of per-unit retains generally 

parallels that of patronage refunds. To qualify for single tax treatment the cooperative 

must, within 8 1/2 months of the end of its 

tax year, either refund the per-unit retain in 

cash or provide the patron with a written 

notice that discloses to the recipient the 

dollar amount retained. That notice is called 

a per-unit retain certificate.

If patrons consent to include the face 

value of the certificates in current income, 

the retained funds are deductible by the 

cooperative in the year the funds were 

acquired and must be included in taxable 

income by the patrons in the year they 

received the required written notice, now 

referred to as a “qualified” per-unit retain 

certificate.

4

To see this and 

other USDA cooperative publications online, visit: 

http://www.rurdev.

usda.gov/rbs/pub/

cooprpts.htm 

To order hard copies, e-mail: 

coopinfo@wdc.

usda.gov

or telephone:

1-800-670-6553.