10 May 2011

Corporate Taxes Are The Exception

According to the IRS in 2008 there were 6,349,720 for profit corporations in the United States. These come in several types.

Pass Through Corporations

Some don't pay income taxes at all and are pass through entities:

S corporations: 4,292,433 (of which 4,049,944 are active)
Form 1120 RIC filers: 13,081 (mutual funds with pass through taxation)
Form 1120-REIT filers: 1,650 (real estate investment trust with pass through taxation)

The active S corporations have, in the aggregate, 6,930,746 shareholders (an average of 1.71 shareholders each). Of the active S corporations, 2,493,706 S corporations (61.6%) have net income; this income is allocated to 4,200,809 shareholders in those corporations (an average of 1.68 shareholders each).

While subchapter S of the Internal Revenue Code allows up to 100 shareholders as of 2004, (and really more, due to the nature of the counting rules) to be shareholders in S corporations, in practice, this is very rare and there is little grass roots pressure to increase the limitation. As of the 2007 tax year, when there were 3,989,893 active S corporations:

2,411,642 had 1 shareholder (60.4%)
1,163,717 had 2 shareholders (29.2%) (thus, 89.6% had 1 or 2 shareholders)
200,183 had 3 shareholders (5.0%) (thus, 94.6% had 1-3 shareholders)
188,531 had 4-10 shareholders (4.7%) (thus 99.4% had 1-10 shareholders)
14,481 had 11-20 shareholders (0.4%)
4,575 had 21-30 shareholders and (0.1%)
3,764 had 31 or more shareholders (0.1%)

Most of the S corporations with 31 or more shareholders are either in the business of accomodations and food service (802) (about 0.4% of S corporations of that type) or "Management of Companies" (1,076) (about 4% of S corporations of that type).

Excluding single owner S corporations, the average number of shareholders per S corporation would be about 2.8 per corporation, which is still fewer partners than any type of entity taxed as a partnership under subchapter K.

In the five year period, total number of active C corporations is down about 15% and the total number of S corporations is up by about 20%.

C Corporations

Others are taxed under the C corporation regime, in some cases with significant modifications:

Ordinary C corporations: 1,995,828 (of which 1,762,483 are active)
Form 1120-F filers: 30,549 (foreign corporations that do business in the U.S.)
Form 1120-PC filers: 7,482 (property and casualty insurance companies)
Form 1120-L filers: 736 (life insurance companies)
Other Corporations: 7961 (mostly from U.S. territories and possessions)

In addition to the 30,549 foreign corporations that must file Form 1120-F, there are 66,797 domestic C corporations that are 50% or more foreign owned. S corporation status is not available for corporations with foreign shareholders.

Of the latter group, there are 1,782,478 active corporations (mostly ordinary C corporations and another 19,997 from other types). Inactive corporations had no taxable income or expenses, but are required to file tax returns in any case.

Of this group of active corporations, 935,939 corporations (52.5% of active corporations that are subject to corporate income taxes) had no net income (i.e. they either broke even or experienced a tax loss), while 846,540 had net income.

Of the 846,540 with net income, 544,331 owed corporate income taxes before credits, and 533,386 owed corporate income taxes net of credits. Thus, just 29.9% of corporations that are subject to corporate income taxes actually owed any corporate income taxes in 2008. Another 17.6% of corporations that are subject to corporate income taxes had net income but owed no corporate incomes taxes for one reason or another (e.g. loss carryforwards and tax credits).

Of the corporations owing any corporate income tax, 360,457 paid less than $6,000 of corporate income tax (all of which is subject to the 15% corporate income tax bracket). These corporations accounted for about 0.3% of all corporate income taxes owed, and for 67.6% of all corporations that owed any corporate income tax.

Another 77,640 corporations owed more than $6,000 but less than $15,000 of corporate income tax, and almost all of that income would have been taxed in the 15% or 25% corporate income tax brackets (which end at $13,750 of tax owed). These corporations account for 0.3% of all corporate taxes owed, and for 14.6% of corporations that owed any corporate income tax.

Thus, 82.2% of corporations that owed any corporate income taxes owed just 0.6% of corporate income taxes owed. (Note that this doesn't necessarily mean that the corporate income tax has no tax revenue effect in these cases, it simply means that it created an incentive to convert most corporate income into taxable compensation in many cases.)

Another 60,055 corporations (11.3% of corporations that owe corporate income taxes) that owed less than $100,000 of corporate income taxes (and thus owed some corporate income taxes in the 34% corporate income tax bracket but received some benefit of the lower 15% and 25% marginal tax rates for corporations before they were fully phased out at $133,900 of taxes due), owed 1.1% of all corporate income taxes.

Thus, 93.5% of corporations that owed any corporate income taxes owed less than 2% of all corporate income taxes.

The 370 corporations owing more than $100 million in corporate income taxes in 2008 owed 64.8% of all of the corporate income taxes owed by all corporations in that year. The next 1,642 corporations (those owing $10 million to $100 million in corporate income taxes in 2008) owed 21.3% of all of the corporate income taxes owed by all corporations in that year. Thus, the 2,012 corporations with the biggest tax bills owed 86.1% of all corporate income taxes. All of this corporate income is taxed at a flat corporate income tax rate of 35% (bubble rates eliminate the benefit of graduated tax rates at lower incomes for these corporations).

In between, there were 37,221 corporations that owed $100,000 or more of corporate income taxes but less than $10,000,0000 of income taxes, overwhelmingly taxed at an average rate of 34% to 35%. The 34% rate is fully phased in at $113,900 of tax owed and the 35% rate is fully phased in at $6.417 million of tax owed. The owe 12.7% of all corporate income taxes.

Thus, 39,232 corporations owe 98.8% of all corporate income taxes, despite being just 0.6% of all corporations required to file an IRS Form 1120, while 91.7% of all corporations required to file an IRS Form 1120 of some kind owe no corporate level federal income taxes. The 1.2% of corporate income taxes paid by the remaining 7.7% of corporations is mostly paid in the 15% or 25% corporate income tax brackets, which can provide tax deferral or reduction to shareholders in the 35% individual income tax bracket that would apply to a pass through entity. In addition, C corporation dividends are not subject to FICA or self-employment taxation, and qualified dividends and long term capital gains from these entities are subject to tax rates of 15% or less.

Entities Taxed As Partnerships

In 2003, there were also about 19 million sole proprietorships and there were "2.5 million businesses in the United States taxed as partnerships with 15.6 million partners, an average of about six partners each":

About 402,000 are limited partnerships (i.e. those with both general and limited partners), with an average of 17 partners each, disproprtionately in the finance and insurance area, and to a lesser extent in the real estate, rental and leasing industries. About 725,000 are general partnerships (i.e. those in which all partners have unlimited liability), with an average of 3.7 partners each. About 1,270,000 are limited liability companies, with an average of 3.9 partners each. About 150,000 are some other form of entity taxes as a partnership (one suspects that limited liability partnerships and limited partner assocations would be in this category, for example), with an average of six partners each.

None of these entities taxed as partnerships owe entity level federal income taxes.

Updated partnership data is available from the IRS. In 2008 there were 1,898,178 LLCs taxed as partnerships (about half in real estate, rental and leasing; 948,862 LLCs with 3,533,512 partners), up about 50% from five years earlier, with 7,524,174 partners (an average of 3.96 each). Some of the largest LLCs, measured by numbers of owners per LLC on average, are in finance and insurance, with 147,327 LLCs and 1,055,783 partners (9.2 each on average). Outside these two industries, the average LLC has 3.6 partners.

In 2008, there were 669,601 general partnerships with 2,623,041
partners (3.9 partners each on average), a drop of about 7% over five years, and 411,698 limited partnerships with 7,054,319 partners (17.1 partners each on average), an increase of about 2% over five years.

Of the general partnerships, 238,586 general partnerships with 925,616 partners were in the real estate, rental and leasing industry, while 74,185 general partnerships with 467,033 partners were in the finance and insurance industry. These industries accounted for about 35% of general partnerships and 53% of general partners. Outside these industries, the average general partnership has about 3.5 partners.

The limited partnerships were concentrated in real estate, rental and leasing (246,760 limited partnerships and 2,048,474 partners) and finance and insurance (77,622 limited partnerships with 2,017,856 partners); the two industries account for almost four-fifths of limited partnerships and almost three-fifths of the partners in limited partnerships. Also notable is the industry of transporation and warehousing that has 1,510 limited partnerships with 1,107,494 partners (an average of 733 partners each).

In the 2008 tax year, there were 3.3 million partnership tax returns filed (up more than 30% over five years), a number that is more comparable to the active corporation numbers than the total corporation numbers because inactive partnerships are not required to file income tax returns, while inactive corporations are required to file income tax returns.


The IRS identifies 1,855,067 non-profit entities that owed no corporate income taxes in 2008, the vast majority of which are organized under Internal Revenue Code Section 501(c), with the vast majority of those being organized under 501(c)(3). There were 901,000 exempt organization tax returns filed in 2008.

Other Entity Types

There were also 3,075,000 estates and trusts that filed tax returns in 2008. There were 30,683,000 employment tax returns filed in 2008, which would include many sole proprietors with employees but would exclude many business entities without employees.

Managerial Variety

For all the myriad choices of entity, there are basically three kinds of ownership structures that are dominant in the United States today.

One is an active closely held business with just a handful of owners who operate largely by consensus.

A second is an essentially passive investment portfolio of either physical assets or financial investments with a medium sized group of investors who are expected (or required) to be largely passive and to defer to a handful of active managers whose shared incentives they rely upon to assure sound management of their investments.

A third is the publicly held corporation, where, in practice, senior management appoints a board of directors that intervenes only in cases of succession crisis or managerial insanity or corporate takeovers, which is largely indifferent to shareholders whose voting rights are basicallly worthless outside a takeover event.

Closely held active businesses with more owners than you could fit around a medium sized conference table (perhaps a dozen to a few hundred), who are involved enough to make considered votes for members of a genuine shareholder representing board of directors, that in turn independently supervises a managerial group on behalf of the shareholders, are very rare in the for profit sector, despite the fact that this is the model for the typical American state corporation statute and is common in the governmental and non-profit sectors.

The typical business that operates on this basis is either a large professional services firms, such as a law firm or accounting firm in which owners are also mostly full time employees of the firm, or is a cooperative, rather than a partnership, or an ordinary corporation. The co-operative business form is discussed in a footnote below.

Choice of Entity

S corporations are attractive because they provide a clear way to reduce FICA taxation, have simpler to comply with tax rules for non-tax experts than limited liability companies, and are consistent with the economic arrangement that many small business owners want. They are a particularly attractive choice for operating businesses without appreciating assets. In contrasts, businesses that primarily own property, particularly if it is likely to appreciate, and businesses that do not qualify to be S corporations due to foreign ownership or complex financial arrangements between co-owners but want pass through taxation treatment favor limited liability companies taxed as partnerships or as disregarded entities. Most new closely held businesses are organized as S corporations or LLCs.

Limited partnerships are chosen over limited liability companies mostly as a result of tradition in certain kinds of investments and because they are the only type of entity that deprives economic owners of almost all voting rights. Limited liability partnerships are typically chosen by professional service partnerships previously organized as general partnerships, to minimize the amount of transition legal and tax work required. General partnerships are usually either chosen by default without counsel, or are between entities or individuals for whom legal liability is not a concern but the ability to fully utilize losses is a concern, since the taxation of unlimited liability general partnerships is simpler than the taxation of limited liability entities taxed as partnerships. Only about a quarter of entities now taxed as partnerships have unlimited liability.

A few state and local jurisdictions (mostly if not entirely in the Northeast) tax S corporations and/or limited liability companies at the entity level, making these choices less attractive and zeroed out C corporations more attractive.

As discussed further below, C corporations are attractive for the anonymity they offer, the fact that one only owes taxes on transactions that produce cash flow for the person taxed (something that venture capitalists often like as a feature), because special tax breaks are available for capital gains in these entities in some circumstances, in some cases for employee benefits reasons, in some cases because they afford low marginal tax rates to high income individuals, and in cases where there are foreign owners, a company is publicly held, or for some other reason no other entity choice is available. One a corporation is a C corporation and has accumulated earnings and profits that have not been distributed as dividends, the tax cost of converting to another form of entity can be great, so many older closely held companies are organized as C corporations out of inertia.

In the current tax environment there can be tax benefits to having C corporations that actually pay corporate level income taxes.

The combination of a 15% entity level corporate income tax and a 15% tax on qualified dividends or long termm capital gains is equivalent to a 28% income tax rate and is FICA free. So, a small amount of entity level taxation produces lower aggregate income taxes than pass through taxation for an individual in the top 35% federal income tax bracket, and with FICA and self-employment tax considerations can also produce lower total taxes for someone in the next lower 25% federal income tax bracket who would otherwise have been subject to the Medicaid portioon of FICA or self-employment taxes.

The combined tax burden on income taxed 25% corporate tax bracket is equivalent to a pass through tax rate of roughly 46%, which is more than the top federal income tax bracket of 35%, but it can mitigate the Medicaid portion of FICA or self-employment taxation, which is almost six percentage points, can allow owner level income earned in a state with a high individual income tax rate to be deferred until the owner moves to a state with little or no individual income taxes, and may even allow the owner to avoid individual level income taxes entirely by holding onto the stock until death when unrealized capital gains taxes are forgiven with the stock liquidated by the individual's heirs. Also, even if there will eventually be a shareholder level tax, taking a tax of 25% immediately rather than 35% immediately can free up cash flow to reinvest in the company providing a tax deferral benefit and a low cost form of business financing in a growth business.


More than 98% of entity level federal income taxes are owed by fewer than 40,000 large C corporations (with the lion's share of those taxes coming from publicly held entities) out of more than 30 million businesses and non-profit organizations in the United States. Corporate level income taxation is the exception rather than the norm.

For the other 99.4% of corporations, the primary purpose of the corporate income tax is to create an incentive to discourage corporations from accumulating corporate level earnings that are not taxed on a pass through basis in a form that prevents them from being taxed at the shareholder level when earned. The pattern observed strongly supports that theory that the vast majority of corporations of any economic consequence act rationally to minimize combined owner-entity level federal taxation through choice of entity and management of compensation arrangements, except in cases where foreign ownership that desires to receive a return on its capital, or the need to have a large number of equity investors to finance the venture makes this effectively impossible.

About 7.7 million business entities are taxes on a pass through basis as S corporations, partnerships, RICs or REITs, and another 4.9 million economic entities are non-profits, trusts or estates that either owe no entity level tax or have the capacity to shift entity level taxation to beneficiaries in a way that would eliminate double taxation.

Of the 1.8 million C corporations, about 70% are "zeroed out" C corporations that owe no entity level corporate income tax after tax credits, and the vast majority of the tax paying C corporations with low amounts of corporate income tax owed appear to choose this form of organization because they benefit from progressive marginal tax rates for low income C corporations either as a form of partial tax deferral or as a means of reducing aggregate tax burdens. "Zeroed out" C corporations have a number of tax virtues related to employee benefits, although they are increasingly marginal, and offer anonymity to owners in years when dividends are not paid. For example, they can provide a way in which individuals who do not have a social security number can operate a business and comply with relevant legal and tax laws (including a taxpayer identification number), so long as some means (e.g. overcompensation of paid employees who can work legally, who in turn financially support the true owners) is found to compensate the owners.

The broad outlines of the data from the 2008 tax year are similar to those of the 2003 tax year about which I previously posted in 2006. There are about 13,000 publicly held corporations (including all corporations with 500 or more shareholders) and about 97,000 foreign owned corporations that do business in the United States that have no choice but to be taxed as C corporations. These businesses pay the lion's share of all corporate income taxes.

Corporate Tax Integration Proposals

Many commentators have proposed to end the double taxation present in C corporations by integrating corporate and shareholder level taxation, typically by affording a deduction for dividends paid, by exempting dividends paid from individual level taxation, by wider use of pass through taxation in a simplified form, or by giving shareholders who receive dividends a tax credit that treats corporate level income taxes as a withholding tax collected in advance from funds to be distributed ultimately as dividends (the most common approach internationally). One proposal to make up the revenue that would be lost if one of these corporate tax integration options were adopted would be to impose a small annual (or otherwise periodic) tax directly upon the fair market value of publicly traded securities like a property tax, since the corporate income tax is already largely a tax on the privilege of operating as a publicly held entity, and because it would be cheap and easy to administer. These reforms would in addition to promoting fairness also reduce the debt-equity distinction that favors debt in the current tax code, which is an important factor in creating systemic risk in the economy. It would also reduce the tax bias between public and privately owned companies that now favors privately owned companies even when this is not optimal from a non-tax perspective.

Footnote On Cooperatives

In 2002, 3,140 farmer cooperatives provided marketing, farm supplies, and services to farmers. This represents a steadily declining number of farmer cooperatives, down from about 10,000 in 1950, and 6,211 in 1981. This decrease in the number of cooperatives reflects the trend of consolidation and merger occurring in production agriculture and in many segments of the food industry.

Of cooperatives operating in 2002, 1,559 primarily marketed farm products, 1,201 primarily provided farm supplies to farmers, and 380 primarily provided other services. Many cooperatives engage in two or all three of these activities.

Cooperatives can also be classified according to organization structure. Centralized cooperatives have only farmer members. Federated cooperatives have only other farmer cooperatives as members. The membership of mixed cooperatives consists of both farmers and farmer cooperatives. In 2002, 3,060 cooperatives were centralized, 53 were federated, and 27 were mixed. Just under 2.8 million producer memberships in farmer cooperatives were reported in 2002. This number includes duplications for farmers who hold membership in more than one cooperative, a common situation.

The tax treatment of patronage refunds paid to patrons and other tax implications of farmer membership affect a great number of farmer taxpayers. The gross business volume of all farmer cooperatives in 2002 was $111.6 billion, up from $90.8 billion in 1991. Marketing represented 69.0 percent of the total, farm supplies 28.3 percent, and selected services 2.7 percent. If inter-cooperative business transactions are eliminated, net business volume was $96.8 billion, up from $76.6 billion in 1991.

Most farmer cooperatives are relatively small businesses. In 2002, 83.8 percent of all farmer cooperatives reported business volume of less than $25 million.

Looking at some balance sheet numbers, combined assets of all farmer cooperatives in 2002 totaled $47.5 billion, up from $31.3 billion in 1991. Total liabilities were $27.9 billion, compared to $17.2 billion in 1991. This leaves net worth, or member and patron equity, at $19.6 billion, a sizable increase over the $14.1 billion of 1991.

The 100 largest cooperatives (the so-called Top 100 in USDA Rural Development publications) usually operate over sizable geographic areas and make up an important segment of the farmer cooperative industry. In 2002, the Top 100 accounted for $64.0 billion in business volume, 57.3 percent of the business volume for all farmer cooperatives.13 They likewise dominated the balance sheet items with $27.2 billion in total assets (57.2 percent of the total) and $8.6 billion in member and patron equity (43.9 percent
of the total).

Eighty-nine of the 100 had earnings in 2002, totaling $817.0 million. How a cooperative uses its earnings affects tax calculations of both the cooperative and its farmer patrons.

These earnings were accounted for in several ways. Cash patronage refunds totaled $194.5 million (23.8 percent). Retained patronage refunds were $394.6 million (48.3 percent). Thus $72 out of every $100 in margins realized by the Top 100 were distributed or allocated as patronage refunds. The eighty-nine cooperatives in the Top 100 for 2002 with earnings paid $74.3 million in corporate income taxes (9.1 percent). Dividends on stock amounted to $1.6 million (0.2 percent) and $152.0 million (18.6 percent) were placed in unallocated reserves.

The 11 cooperatives in the Top 100 that suffered losses in 2002 had total losses approaching $675 million. Close to $35 million was covered with tax benefits and approximately $300 million was set off against unallocated equity. The remainder is either being carried on the cooperatives’ books or being recovered from patronage equities. . . .


The National Cooperative Business Association reports that in the United States a network of 48,000 cooperatives directly serve 120 million people -- nearly 40 percent of the population. . . .

The largest single segment of the cooperative industry is credit
unions. The roughly 10,000 credit unions in the United States
have more than $600 billion is assets and 83 million members.

Building on their base of member savings and consumer loans and home mortgages, credit unions now offer additional services to their members including credit cards, automated teller machines, tax-deferred retirement accounts and certificates of deposit.

Created in 1916, the cooperative Farm Credit System is the nation's oldest and largest financial cooperative. It provides real estate loans, operating loans, home mortgage loans, crop insurance and various other financial services to more than 500,000 farmer, small-town resident and cooperative borrowers. It loans roughly $90 billion annually to its members.

One element of the Farm Credit System is CoBank. It has about $25 billion in outstanding loans and leases to farmer and rural utility cooperatives and water and waste disposal systems. CoBank has become an important financier of exports of U.S. farm products as it broadens its role of making credit available to enhance farm and rural income.

Since 1969, the National Rural Utilities Cooperative Finance Corporation (CFC) has been a valuable source of financing for rural electric and telephone cooperatives. With $21 billion in assets and almost $21 billion in credit outstanding, CFC supplements funding provided by USDA's Rural Utilities Service and provides business services to its borrowers. In a short period of time, the National Cooperative Bank (NCB) has become an important financial institution for America's housing, business and consumer cooperatives. Chartered by Congress in 1978 and private since 1982, NCB has originated more than $6 billion in loans to nearly 2,000 cooperatives throughout the country. NCB has become a leader in providing development funding for new, non-agricultural cooperatives and in devising methods of attracting outside capital to leverage its investments.

Nearly 1,000 rural electric cooperatives own and maintain nearly half of the electric distribution lines in the United States, cover 75 percent of the land mass, and provide electricity to 36 million people.

Roughly 270 telephone cooperatives are providing a growing portfolio of communications services to 2 million households, including wireless technology and high-speed Internet access.

More than 1,000 mutual insurance companies, with more than $80 billion in net written premiums, are owned by their policyholders.

America has about 1 million units of cooperative housing, nearly 600,000 of them in New York City. New units are being developed in many other sectors, including senior citizen communities, trailer parks, low-income complexes, and student housing near college campuses.

Millions of Americans receive basic medical care through cooperatively organized health care providers. Health maintenance organizations (HMOs) serve more than 1 million people coast-to-coast and will likely be an increasingly important part of the health care system in the years ahead. In several major cities-- Seattle, Minneapolis, Memphis, Sacramento, Salt Lake City and Detroit--companies have formed cooperative health alliances to purchase health care for their employees.

Child care cooperatives are meeting the needs of families where the parent(s) are employed and want affordable care. These centers can be organized by parents on their own, by a single employer, or by a consortium of businesses providing a single center for the group. More than 50,000 families use cooperative day care centers daily.

Some business cooperatives manufacture or otherwise procure products for their retail outlet members. For example, more than 15,000 independent grocery stores rely on cooperative grocery wholesalers for identity, brand names, and buying power they need to compete with the chains and the discounters. Members also receive training and financing. Several cooperative grocery wholesalers are multi-billion-dollar firms rivaling the largest farmer cooperatives in sales and assets.

Cooperatively owned hardware wholesalers supply virtually all of the independent hardware stores in the United States. As huge warehouse chains spread across the nation, the independents are relying more and more on TruServ, Ace Hardware, Do-it-Best, and other cooperatives for products, promotions and education to remain viable businesses.

Other business cooperatives negotiate group purchase contracts with suppliers and their members purchase the goods and services they need directly from those suppliers. A leader in this group is VHA. More than 2,200 hospitals and other health care providers purchase $20 billion annually in supplies and services under contracts negotiated by this cooperative.

Restaurant supply purchasing cooperatives save money and provide quality products for both company-owned outlets and franchisees of several fast-food chains. These firms include Unified Foodservice Purchasing Co-op (A&W, KFC, Long John Silver’s, Pizza Hut, and Taco Bell) and Restaurant Services, Inc. (Burger King). Besides their bottom-line impact, purchasing cooperatives also offer another, less tangible benefit: they help to build trust among franchisers and franchisees, particularly on pricing issues.

Cooperatives are leaders in other major industries, including media and news services (Associated Press), outdoor goods and services (Recreational Equipment Inc.), lodging (Best Western), carpeting (Carpet One), electrical distributors (IMARK), natural foods, and collegiate bookstores. . . .


As one form of business corporation, cooperatives calculate taxable income and use tax rates like other corporations, but with one principal difference. This difference reflects cooperatives' distinct way of distributing net margins to its patrons based on use, rather than to investors based on investment. . . .

The general principle of cooperative income taxation is that money flows through the cooperative and on to patrons, leaving no margins to be retained as profit by the cooperative. Thus margins are taxed only once. The tax is ultimately paid by the final recipient (the cooperative patron), although under some circumstances the cooperative pays tax on a temporary basis, then receives a deduction when the money is finally passed on to the

This single tax principle only applies if business income sources and distribution methods are "cooperative" in nature. Earnings from sources other than patronage and margins not distributed in the manner specified by the Code are generally not eligible for single tax treatment. The critical issue [is] in distinguishing patronage- and nonpatronage-sourced income . . . . General corporate income tax rules apply to earnings from nonpatronage sources and double taxation results.

When statutory conditions are met, cooperatives treat retained patronage refunds and per-unit retains as if the funds retained had been paid to the patron, deducted by the cooperative, taken into the patron's income as ordinary income, then invested in the cooperative. Conditions for this tax treatment include agreement by the patron to recognize the full patronage refund for tax purposes even though not received in cash or negotiable form.

Farmer cooperatives that meet several organizational and operational rules set out in Code section 521 are allowed to deduct two additional items: (1) dividends paid on capital stock and (2) distributions of nonpatronage earnings to patrons on the basis of their patronage.

Subchapter T of the Code, "Cooperatives and Their Patrons," contains most of provisions directly related to cooperative taxation and the taxation of patrons. Part I of subchapter T consists of three sections. Section 1381 describes cooperative organizations to which subchapter T applies. Subchapter T applies to all farmer cooperatives, including farmer cooperatives qualifying under section 521. A business need not be a farmer cooperative to qualify for subchapter T tax status. Any business "operating on a cooperative basis" uses subchapter T when computing its tax liability.

Farmer cooperatives file on form 990-C. Other cooperatives file form 1120. . . . Cooperatives must report such distributions to IRS (form 1096) and to the patron receiving the distribution (form 1099-PATR). Section 6044(c) provides an exemption from reporting for certain consumer cooperatives.

From here (the U.S. Department of Agriculture source is in the public domain).

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