With the housing market getting more difficult by the minute, alternative forms of housing ownership are growing in popularity—including cooperative housing arrangements. In a housing cooperative, the complex is jointly owned by its residents, who buy a “share” of the complex similar to how one would buy stock in a corporation and enjoy benefits similar to shareholders.
However, a cooperative business structure is not exclusive to housing. Other types of cooperatives one might be familiar with include:
Essentially, the defining factor of a cooperative is that it is member-owned and often member-operated. Keeping this in mind will help us understand the difference between “patronage” income vs. “non-patronage” income within the cooperative structure.
According to IRS Regulations Section 1.1388-1-(f)(2), an income or expense item is considered patronage if it is produced by a transaction that facilitates the accomplishment of the cooperative’s purpose. The IRS has also ruled transactions must also be performed with its member-owners to qualify as patronage.
On the other hand, non-patronage income is generated when (I) the transaction does not facilitate the accomplishment of the cooperative’s purpose and merely occurs incidentally as a way to increase overall profitability or (II) the transaction is notperformed with a member-owner, whether it relates to the cooperative’s purpose or not.
The following examples illustrate the differences between patronage and non-patronage income in plain English:
A Housing Cooperative: GoodNeighbors Cooperative houses primarily member-owners but also rents a few of their open units to non-members. Rental income received from member-owners would be patronage, while rental income received from non-members would be nonpatronage.
The same logic applies to general expenses (real estate taxes, interest expense, etc.) allocated among member-owners and non-members. The portion allocated to member-owners would be patronage, and vice versa.
A Grocery Cooperative: SaveMoney Grocery Cooperative owns two units in a strip mall, one of which contains its grocery store. The other unit is leased out to another business. As leasing the other unit does not facilitate the cooperative’s purpose of providing groceries, the income would be considered non-patronage.
Additionally, like GoodNeighbors, grocery sales made to member-owners would be patronage income, while sales to non-members would be non-patronage income.
Lastly, we come to taxation. Let’s say we have successfully used the principles above to divide our income and expenses into patronage and non-patronage. How are these two “buckets” taxed?
Taxation of patronage income resembles how partnerships are taxed. Usually, cooperative taxes are passed through to the member-owner through the payment of patronage dividends, which the co-op deducts as expenses, and is generally then taxed at the individual member level. Taxation of non-patronage income, on the other hand, resembles corporate taxation. Income is taxed once on the tax return filed (Form 1120-C), then is taxed again when it makes its way down to its recipients.
Cooperative business arrangements can be a very beneficial way for a group to operate various kinds of activities, from housing and utilities, to groceries and a host of other products and services, ,, while enjoying many tax savings. However, these tax savings come with additional complications that participants need to become educated about to ensure financial success. Understanding the different types of taxation for patronage and non-patronage net income is among the more important factors to be understood.