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Cooperatives are business entities democratically controlled by their patrons with each member possessing one vote. They allocate their net margins from the business done with their patrons back to their patrons in proportion to patronage.
Regarding income tax treatment of cooperatives, under section 1382, taxable income is calculated similar to a corporation with the exception that income of the cooperative that is attributable to patron business is excluded or deducted from income when it is allocated to the patrons. When allocated, the patrons realize income and patronage-sourced income flows through the cooperative so that it is taxed only once. Section 521 applies to tax exempt farmers’ cooperatives.
Under section 1388, patronage dividend is defined as the amount paid to a patron on the basis of quantity or value of business done with such patron, under an obligation of such organization to pay such amount, and which is determined by reference to net earnings. Patronage dividends can be in the form of money, property, or written notices of allocation, the latter of which is defined as capital stock, revolving fund certificate, retain certificate, certificate of indebtedness, or letter of advice. If the notices are qualified, they are deductible.
Recurring controversies surrounding taxation of cooperatives include determining what constitutes patronage-sourced income, whether payments to members are allocations paid in money, and the applicability and computation of the domestic production activities deduction under section 199.
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