Cooperative Business Organizations

Cooperative Business Organizations

In the economic times that we find ourselves operating in, most businesses are dealing with decreases in revenue, increases in operating costs and increasing financial pressures put on them by their financial institutions. One overlooked alternative to assist in controlling costs and purchasing function is the cooperative business organization. These organizations are common in the retail, food service, healthcare, financial services, manufacturing and agricultural industries. A cooperative is a business or organization owned by and operated for the benefit of those using the services. The earnings generated by the cooperative are then distributed among the members through patronage dividends.

The National Cooperative Business Association (NCBA) estimates that there are 250 purchasing cooperatives in the United States which are offering group buying services benefiting their members. They vary in size and membership base, but share values and principles. The NCBA has established seven principles to define cooperatives. They are as follows:

  1. Voluntary and open membership;
  2. Democratic member control;
  3. Member economic participation;
  4. Autonomy and Independence;
  5. Education, training and Information;
  6. Cooperation among cooperatives;
  7. Concern for community

There are numerous advantages to being a member of a cooperative. They include preferential vendor pricing, supply purchasing, product branding, joint marketing, common billing and delivery services, common warehousing, training / education and joint management services.

circle of peopleExisting cooperative buying organizations can be found through many sources. A search tool can be found on the NCBA web site to assist potential members in finding organizations in their respective industries. Typically, new members purchase stock in the existing cooperative. In addition to their original investment, the member receives yearly patronage dividends from the cooperative. The patronage dividends, which are subject to tax to the member, are calculated based on the basis of the quantity or value of business done by the cooperative with or for each patron in relation to the net earnings of the cooperative. Patronage dividends are separate and distinct from stock dividends.

An alternative to joining an existing cooperative is forming a new entity. Groups of like-minded individuals must agree on a common need and strategy. If potential members choose to incorporate a new cooperative they must:

  • Create bylaws;
  • File articles of incorporation;
  • Register with the Internal Revenue Service, register with state and local tax agencies;
  • Conduct a member meeting and elect a board of directors;
  • Create a membership application;
  • Obtain relevant business licenses and permits;
  • Hire employees, including a manager.

The keys to success for any cooperative include using advisors and committees effectively, keeping members informed and involved, maintain a good relationship between the board of directors and the manager, conducting comprehensive and efficient meetings, following sound business practices and developing alliances with other cooperatives.

Common reasons that a cooperative may fail include lack of a clear mission, inadequate planning, failure to use qualified advisors, lack of leadership and member commitment, lack of financing and failure to communicate with members, suppliers and their financial institutions.

TAXATION OF COOPERATIVES

Although cooperatives are generally taxed as normal corporations, they receive a benefit in that they can deduct, from their gross income, the amount of patronage dividends paid to their members. A patronage dividend is essentially a “refund” paid to the member. In order to qualify for the federal tax deduction, patronage dividends must, under 26 U.S.C. § 1388(a) must meet the following three criteria:

  • Each patronage dividend must be based upon the basis of the quantity or value of business done by the cooperative with or for each patron;
  • The cooperative must have obligated itself to issue a patronage dividend before the cooperative receives the income out of which it pays the dividend;
  • Each patronage dividend must be calculated with reference to the net earnings of the organization from business done with or for its patrons.

Under 26 U.S.C. § 1382(b),, cooperatives are permitted to issue “qualified written notice of allocation” such as shares of stock, certificates of indebtedness or redeemable notes in lieu of cash.

Some cooperatives, like credit unions and rural utility cooperatives, are exempt from federal taxation. The state tax treatment for cooperatives varies from state to state.

For more information on the topic discussed, please contact your local WS+B advisor or:
Glenn Bellomy, CPA, Partner, Practice Leader
Consumer Product Services and Entertainment Services
732.842.3113 ? [email protected]

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