Patronage dividend

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• cooperative
• dividends
• equity
• net income
• return on investment
• taxable income
• balance sheet
• capital gains
• deductions
• income statement
• financial statements
• mutual funds
• credit unions
• profit sharing
• retained earnings

What Is Patronage Dividend?

A patronage dividend is a distribution of a cooperative's net earnings to its members, proportional to their use of the cooperative's services or products, rather than their ownership stake. This form of distribution is central to the operational and financial structure of a cooperative, distinguishing it within the broader category of business finance. Unlike traditional corporate dividends, which are paid to shareholders based on their equity ownership, patronage dividends reflect a member's active participation and engagement with the cooperative. These payments aim to reduce the effective cost of goods or services purchased by members or increase the price received for products sold through the cooperative. The concept of a patronage dividend reinforces the member-centric nature of cooperative enterprises, aligning financial returns with the level of member activity.

History and Origin

The concept of cooperatives and their unique method of distributing profits, including the patronage dividend, has roots dating back centuries. Modern cooperative movements gained significant traction in the 19th century, particularly with the Rochdale Pioneers in England in 1844, who are often credited with establishing many of the principles that guide cooperatives today, including the distribution of surplus to members in proportion to their transactions.

In the United States, the cooperative model, and by extension the patronage dividend, became particularly prevalent in agricultural and rural sectors. Organizations like the National Cooperative Business Association (NCBA CLUSA), founded in 1916 as the Cooperative League of America, have played a significant role in promoting and supporting cooperative enterprises. The Rural Electrification Administration (REA), established in 1935 by President Roosevelt, further propelled the growth of electric cooperatives, which similarly utilized patronage dividends to return surplus funds to their members. By 1953, electric cooperatives had brought electricity to 90 percent of U.S. farms.⁸ The Federal Reserve Bank of San Francisco has also highlighted the role of cooperatives in rural economic development.⁷

Key Takeaways

• A patronage dividend is a distribution of a cooperative's surplus earnings to its members based on their transactions, not their capital contribution.
• These dividends can be paid in cash, qualified written notices of allocation, or other forms.
• Patronage dividends generally reduce the cost of goods or services for members or increase the price received for products sold.
• They are typically tax-deductible for the cooperative, provided certain IRS requirements are met, and are taxable income for the recipient.
• Form 1099-PATR is issued to report patronage dividends received by members.

Formula and Calculation

The calculation of a patronage dividend involves determining the cooperative's net income attributable to patronage (business conducted with members) and then allocating that income based on each member's volume of business.

The general concept can be illustrated as follows:

$\text{Patronage Dividend} = \text{Member's Share of Patronage Business} \times \text{Net Income from Patronage Activities}$

Here's a breakdown of the variables:

• Member's Share of Patronage Business: This is typically represented as a ratio of a member's individual transactions with the cooperative to the total patronage business conducted by the cooperative during a specific period. For example, if a member purchased $1,000 worth of goods from a cooperative that had total patronage sales of $100,000, their share would be 1%.
• Net Income from Patronage Activities: This refers to the cooperative's profit generated specifically from business activities with its members, after all expenses related to those activities are deducted. This figure is crucial because non-patronage income (e.g., income from non-members) cannot be distributed as patronage dividends.

The calculation of net income involves analyzing the cooperative's income statement and other financial statements to isolate the earnings directly tied to member transactions.

Interpreting the Patronage Dividend

Interpreting a patronage dividend primarily involves understanding its impact on a member's effective cost or revenue and its tax implications. A larger patronage dividend generally signifies a more financially successful cooperative and, for members, a greater reduction in the actual cost of their purchases or an increase in the true value of their sales.

For a member, receiving a patronage dividend effectively lowers the price of the goods or services they purchased from the cooperative or increases the price they received for goods sold to the cooperative. This direct financial benefit distinguishes it from traditional corporate profit sharing.

The Internal Revenue Service (IRS) generally considers patronage dividends to be taxable income for the recipient, provided they are qualified written notices of allocation. Cooperatives issue IRS Form 1099-PATR to members who receive at least $10 in patronage dividends. The cooperative can often deduct these dividends from its own taxable income, effectively avoiding corporate-level taxation on that portion of its earnings. This tax treatment is a significant advantage for cooperatives and their members, as detailed in IRS Publication 542, which outlines tax rules for corporations and cooperatives.⁶

Hypothetical Example

Imagine "Green Acres Co-op," an agricultural cooperative that supplies seeds and equipment to its farmer members. In a fiscal year, Green Acres Co-op has $1,000,000 in total sales to its members and generates a net income of $100,000 from these patronage activities. The cooperative decides to distribute 60% of this patronage net income as patronage dividends.

Farmer Jones, a member of Green Acres Co-op, purchased $20,000 worth of seeds and equipment from the co-op during the year.

1. Calculate the total distributable patronage dividends:
   $100,000 (Net Income from Patronage) $\times$ 60% (Distribution Rate) = $60,000

2. Determine Farmer Jones's share of patronage business:
   $20,000 (Farmer Jones's Purchases) $\div$ $1,000,000 (Total Patronage Sales) = 0.02 or 2%

3. Calculate Farmer Jones's patronage dividend:
   $60,000 (Total Distributable Dividends) $\times$ 0.02 (Farmer Jones's Share) = $1,200

So, Farmer Jones would receive a patronage dividend of $1,200. This $1,200 effectively reduces the cost of the $20,000 worth of supplies he purchased, enhancing his return on investment in his farming operations through the cooperative. The cooperative would issue a Form 1099-PATR to Farmer Jones for this amount.⁵

Practical Applications

Patronage dividends are a cornerstone of cooperative finance, appearing in various sectors.

• Agricultural Cooperatives: Farmers often form or join cooperatives to purchase supplies, market their produce, or process their goods. Patronage dividends allow these cooperatives to return profits to members, effectively reducing input costs or increasing sales prices. For instance, a dairy cooperative might distribute patronage dividends to its member farmers based on the volume of milk supplied.
• Consumer Cooperatives: These include grocery cooperatives, housing cooperatives, and credit unions. Members receive patronage dividends based on their purchases or use of services. For example, a consumer-owned grocery store might return a portion of its profits to members who shop there, based on their spending.
• Utility Cooperatives: Many rural areas are served by electric or telephone cooperatives. These cooperatives often return surplus revenues to their members in the form of patronage dividends, which can reduce the cost of utility services over time.
• Wholesale Cooperatives: Retail businesses might form a wholesale cooperative to leverage collective purchasing power. The patronage dividends would then flow back to the member businesses, reducing their cost of goods sold.

The IRS provides specific guidance on the taxation of cooperatives and patronage dividends in publications such as IRS Publication 542.⁴ Additionally, the IRS issues Form 1099-PATR for reporting these distributions, underscoring their significance in the U.S. tax system.³

Limitations and Criticisms

While patronage dividends offer distinct advantages for cooperative members, certain limitations and criticisms exist:

• Taxable Income for Recipients: Although patronage dividends can be tax-deductible for the cooperative, they are generally considered taxable income for the recipient in the year they are received or allocated. This means members must account for these distributions on their tax returns, potentially increasing their tax liability.²
• Variability of Payouts: The amount of patronage dividend a member receives is directly tied to the cooperative's profitability and its decision on how much of its retained earnings to distribute. This means payouts can fluctuate year-to-year, offering less predictability than fixed dividends from traditional corporations.
• Non-Cash Distributions: Patronage dividends are not always paid in cash. Cooperatives may issue qualified written notices of allocation, which are essentially promises to pay the dividend in the future, or allocate the funds to the member's capital account on the cooperative's balance sheet. While these non-cash distributions still represent a financial benefit and are often taxable to the member, they do not provide immediate liquidity.
• Complexity for Tax Reporting: For both cooperatives and members, correctly reporting patronage dividends for tax purposes can be complex. Cooperatives must adhere to specific IRS regulations to ensure the dividends are deductible, and members need to understand how to report them on their individual or business tax returns, often requiring Form 1099-PATR.
• Member Understanding: Some members may not fully understand the nature of patronage dividends, especially when they are not received as immediate cash. This can lead to misconceptions about the cooperative's financial performance or the value of their membership.

Patronage Dividend vs. Stock Dividend

The key distinction between a patronage dividend and a stock dividend lies in their basis of distribution and the underlying organizational structure.

While a patronage dividend reflects the member-centric model of a cooperative, where benefits are tied to usage, a stock dividend is a corporate action where a company distributes additional shares to its shareholders, reflecting their existing equity investment. Stock dividends do not typically represent a direct financial payout but rather an increase in the number of shares held, which can impact future share prices and potential capital gains.

FAQs

Are patronage dividends always paid in cash?

No, patronage dividends are not always paid in cash. They can be paid in cash, but also in qualified written notices of allocation (which are essentially promises to pay the dividend at a later date), or by increasing a member's capital account within the cooperative. The specific form of payment depends on the cooperative's policies and financial health.

Are patronage dividends taxable?

Yes, generally, patronage dividends are considered taxable income to the recipient in the year they are received or allocated. Cooperatives are required to report these distributions to the IRS and to their members using Form 1099-PATR.¹

How do patronage dividends benefit cooperative members?

Patronage dividends benefit cooperative members by reducing the effective cost of goods or services they purchase from the cooperative or by increasing the price they receive for products they sell through the cooperative. This direct financial return is proportional to their engagement and utilization of the cooperative's offerings, fostering a sense of ownership and shared success.

What is Form 1099-PATR?

Form 1099-PATR is an IRS tax form titled "Taxable Distributions Received From Cooperatives." It is issued by cooperatives to their members to report patronage dividends and other distributions of at least $10 that may need to be included in the member's taxable income.

Do all cooperatives pay patronage dividends?

Not all cooperatives are required to pay patronage dividends. The decision to distribute patronage dividends, and the amount thereof, is typically made by the cooperative's board of directors, based on its financial performance and its articles of incorporation and bylaws. While many cooperatives aim to return surplus earnings to members, some may choose to retain more earnings for reinvestment in the cooperative or for other purposes.