Years of retained patronage can build into a significant future cash obligation for a cooperative. Those retained balances may provide valuable working capital today, but as more patrons become eligible for redemption, the cooperative needs a plan for returning that equity without creating unnecessary pressure on cash flow.
When a cooperative allocates patronage to its members, it may distribute part of that amount in cash and retain the remainder as patronage equity. The retained portion can help finance operations, capital improvements and other long-term needs.
Retained Patronage can help finance:
Operations
Capital Improvements
Long-term Needs
Timing can become an issue when redemption policies are tied to age, retirement or another milestone. For cooperatives with a large group of patrons approaching those thresholds at the same time, future redemption requests can become concentrated within a relatively short period.
We encourage cooperatives to include retained patronage in their longer-term cash flow planning before those obligations come due. Understanding when outstanding balances may become eligible for redemption gives management and the board more time to evaluate strategies for managing those payments.
A note on the tax treatment of retained patronage
The tax impact of a patronage redemption depends in part on whether the original allocation was issued as a qualified or nonqualified written notice of allocation.
Qualified allocations are generally included in the patron’s taxable income when originally issued. Nonqualified allocations generally create tax consequences when the cooperative later redeems them. Cooperatives should understand which type of patronage equity they have outstanding before changing their redemption strategy.
Retained patronage practices can also vary considerably by type of cooperative. In our experience working with co-ops, most have distributed 100% of their patronage dividends each year rather than retaining a portion as equity. For some, patronage dividends represented 90% or more of gross revenue, making the distribution function more like a purchase rebate than an allocation of profits.
For cooperatives that do retain patronage, however, it is important to consider how those balances will eventually be redeemed and how those payments could affect future cash flow.
Read related resource: Patronage Dividends for Food Co-ops
Option One
Redeem retained patronage by allocation year
How it works: A cooperative can establish a revolving equity plan that periodically redeems retained patronage by allocation year.
While some cooperatives may begin with the oldest outstanding allocations, redemptions do not necessarily have to occur strictly from oldest to newest. Depending on available cash flow, the board may choose to redeem a smaller allocation year or only a portion of a given year’s balance.
This flexibility can help the cooperative manage its cash requirements while still creating a more predictable cycle for returning patron equity and allowing newer retained allocations to continue supporting the cooperative’s capital needs.
Potential tax ramifications
- Redemption generally does not cause qualified patronage equity to be taxed to the patron a second time because it was typically included in income when originally allocated.
- Nonqualified patronage equity generally creates income for the patron when it is redeemed, with a corresponding deduction or adjustment generally available to the cooperative.
- Changing the timing or allocation years selected for redemption generally affects the timing of cash payments rather than changing the original tax character of the patronage equity.
Option Two
Redeem retained patronage based on patron age
How it works: Some cooperatives allow patrons to request redemption once they reach a specified age.
An age-based system can provide a clear and understandable benefit to patrons, but it can also create periods when many members become eligible at once. Cooperatives using this approach may want to establish additional parameters, such as an annual redemption budget or a process for spreading eligible requests across multiple years.
Reviewing the age distribution of current patrons can help the cooperative estimate how much retained equity may become eligible for redemption in future years and plan its cash needs accordingly.
Potential tax ramifications
- Reaching a specified age does not generally determine the federal tax treatment of the redemption. The original structure of the patronage allocation remains important.
- Qualified patronage equity was generally taxable when originally allocated, while nonqualified patronage equity generally becomes taxable when redeemed.
- Strong recordkeeping is important when patron accounts contain allocations from different years or with different tax treatment.
Option Three
Pay retained patronage over multiple years
How it works: A cooperative may be able to revise its bylaws or redemption policy so an eligible patron’s balance does not have to be paid entirely at once.
Instead, the cooperative could redeem portions of the balance over several years based on an established schedule or the amount of funding available for patronage redemptions each year.
This approach can make cash requirements more predictable, particularly when individual patrons have accumulated large balances or when many patrons become eligible during the same period.
Any changes should be reviewed against the cooperative’s bylaws, applicable state law, financing agreements and board authority.
Potential tax ramifications
- For qualified patronage equity, paying the balance over multiple years generally affects the timing of cash payments more than the timing of taxable income
- For nonqualified patronage equity, each redemption may create tax consequences in the year the payment occurs.
- Changes to the timing of redemptions may also affect the cooperative's tax reporting, including applicable Form 1099-PATR requirements.
Read related resource: Where to Report Patronage Dividends (1099-PATR) on Your Form 1040
Build a retained patronage strategy before redemptions strain cash flow.
When we work with cooperatives on retained patronage, we encourage them to look beyond the total balance on the books. Understanding when different groups of patrons may become eligible for redemption, and how those payments could overlap, can provide a much clearer picture of future cash needs.
A few questions can help focus the conversation:
- How much retained patronage is currently outstanding?
- When are different groups of patrons expected to become eligible for redemption?
- How much could the cooperative reasonably redeem each year without disrupting operations or other capital needs?
From there, the cooperative can evaluate whether a revolving schedule, age-based redemptions, payments over multiple years or a combination of strategies best fits its needs. Before making changes to a patronage redemption policy or bylaws, we also recommend reviewing the tax, financial and governance implications with the cooperative’s tax and legal advisors.
If your cooperative is reviewing its retained patronage balances or considering changes to its redemption approach, our cooperative advisors can help evaluate the tax implications and think through how different strategies may affect future cash flow.
