While recently working with a client, I came across a situation I typically do not deal with on a routine basis: non-qualified patronage distributions from a cooperative.
A qualified distribution is treated as a deduction on the cooperative return and the producer picks up the income amount. On the contrary, the cooperative does not get a tax deduction when a non-qualified distribution is given and the producer does not pay tax on that amount. The IRS defines a qualified patronage dividend as amounts paid:
- on the basis of quantity or value of business done with or for such patron,
- under an obligation of such organization to pay such amount, which obligation existed before the organization received the amount so paid, and
- which is determined by reference to the net earnings of the organization from business done with or for its patrons.
The amount paid in cash must also be 20% or greater of the total distribution, which is what caused the distribution I was working with to be non-qualified. Essentially, the producer’s patronage equity account was increased by the non-qualified distribution amount, but no cash was received by the producer.
To correctly reflect this on the books of the client, we needed to increase the patronage equity account (an asset) as well as patronage income. You will recall, however, that a non-qualified distribution is not taxable to the producer. Therefore, we also made an equal adjustment on the schedule M-1 – Reconciliation of Income (Loss) per Books with Income per Return.
For example, let’s say Farmer Joe receives a statement from a cooperative that shows he received $5,000 in patronage equity, but nothing was received in cash and also had net income of $100,000. To correctly state his investment in the cooperative, Farmer Joe would need to increase his investment asset by the $5,000 as well as book net income by $5,000. Book net income would then be $105,000. To correctly report this on the tax return, however, there would be an adjustment on the schedule M-1 that decreases taxable income to $100,000. Farmer Joe will not pay tax on the patronage until it is paid out in cash in the future.
Therefore, it is important to let your tax advisor know of this situation if it arises or give them all documents related to anything patronage as it may go unnoticed otherwise for cash basis taxpayers as no cash was ever received! This could be even more important if you have financial statements prepared or give the tax return to the bank for any loan renewals as that extra bit of income (as well as an increased asset balance) always helps!