2.205 Deduction for Certain Dividends of Cooperatives

Origin: Cooperatives are organizations comprised of separate businesses that band together for limited purposes to take advantage of economies of scale, for example when buying supplies or selling products. Farmers' cooperatives and certain corporations acting as cooperatives may deduct so-called "patronage dividends" from their gross incomes. A "patronage dividend" is a dividend paid to members of the cooperative: (i) based on the quantity or value of business done with the members, (ii) under a pre-existing obligation of the cooperative; and (iii) determined by the cooperative's net earnings from business with members. In order to deduct the dividends, cooperatives must provide notice to members of the total patronage dividend and must pay a minimum of 20% of each member's dividend in cash within 8½ months following the close of the cooperative's taxable year. The deduction is based on the notion that the cooperative is an agent working for the members and that any funds transferred to members already belong to the members. See Farm Service Cooperative v. Commissioner, 619 F.2d 718, 722 (1979). In this view, the primary function of a cooperative is the allocation of the economic benefits of the cooperative, either in the form of net savings or net earnings. The deduction recognizes that taxing patronage dividends would discourage such allocation and could result in double taxation of income (first when earned by the cooperative and second as a dividend received by the member).

Origin: IRC §§1381-1388