retains from sales proceeds and not patronage refunds. On March 2, 1955, the U.S. Court of Appeals (Fifth Circuit) affirmed the earlier Tax Court opinion in B. A. Carpenter.66 Finally, on October 28, 1955, Moe v. Earle was affirmed by a per curiam opinion, and, on April 9, 1956, the Supreme Court of the United States denied certiorari.67 Subchapter T and Related In 1961, the President proposed the collection of a single tax currently either from cooperatives or their patrons, "assessing the patron," as his message said, on the amounts that are "allocated to him as patronage dividends or refunds in scrip or cash." The President was specific in his recommendation that farmer cooperatives should not be penalized by assessing a patronage tax on them, if their members elect to leave their patronage allocations with their cooperatives for capital purposes.68 In other words, it was recognized that cooperatives needed to be capitalized by their patron members-that this was the only feasible way for them to do it and all that was asked for in the tax laws was that there be a single tax collected currently. The 1961 legislative proposals that became subchapter T in 1962, were backed up by recommendations that took into account the distinctive characteristics of cooperatives. The Internal Revenue Code now contains detailed provisions on the taxation of cooperatives and their patrons. The pertinent provisions are section 521 and subchapter T (sections 1381-3, 1385, and 1388). Those farmer cooperatives qualifying under section 521 of the Code, while subject to income tax, are generally in position to operate with little or no taxable income. This does not mean that income escapes taxation. The cooperative will end up with little or no taxable income only to the extent that the patrons include the amounts involved in their taxable income.69 66 Commissioner v. B. A. Carpenter, 219 F. 2d 635 (5th Cir. 1955). 67 Moe v. Earle, 226 F. 2d 583 (9th Cir. 1955), cert. den., 350 U.S. 1013 (1956). 68 H.R. Doc. No. 140 (vol. 1), 87th Cong., 1st sess. 14 (1961), Hearings on President's 1961 Tax Recommendations before the Committee on Ways and Means. 69 See "Taxation of Cooperatives and Patrons Under Subchapter T," p. 426. Farmer cooperatives that do not qualify as section 521 cooperatives are liable for income tax on amounts devoted to the payment of a return on capital and on amounts which they do not return to patrons as patronage refunds in the manner prescribed by the Code. As noted previously,70 Congress had sought to tax "income" generated through cooperative activity at least once-either to the cooperative, if unallocated, or to the patrons, if allocated to them. The 1951 Act removed the exemption for farmer cooperatives (although still referring to them as "exempt") and provided that in addition to all other deductions permitted corporations generally, those cooperatives meeting the requirements of section 521 would have the two deductions specified in section 522. Patronage refunds were also made nontaxable to cooperatives by the 1951 legislation, if allocated to patrons pursuant to a prior mandatory obligation-the courts and Treasury rulings already having established this right on the part of cooperatives. The 1951 effort to impose a single tax currently at either the cooperative or patron level was not successful. Questions arose concerning the income tax liability of patrons." The courts, while approving the right of cooperatives to exclude from taxable income the full amount of properly authorized patronage refunds, would not allow tax collections at the patron level on the stated dollar amount of noncash patronage refunds. The courts had concluded that allocations of noncash patronage refunds (to the extent they reflected business activity) were currently taxable to the patron only to the extent of their "fair market value," even though they were deductible in full by the cooperative. Arguments that many patrons were regularly including the full amount of their refunds in taxable income, as required by Treasury, and that separate and distinct taxpayers were involved the cooperative on the one hand and the patron on the other-were of no avail. Legislative clarification was sought. The Revenue Act of 196272 was enacted. The 1962 Act repealed section 522, which in 1951 had subjected "exempt" farmers' cooperatives to income tax, and added a 70See "Taxation on 'Exempt' Cooperatives Under the 1951 Act," p. 363. 71See "Taxability of Patronage Refunds to Patrons-Pre-1962 Treatment," p. 376. 7276 Stat. 1045-51. new subchapter T (sections 1381-3, 1385 and 1388) to the Internal Revenue Code of 1954. Subchapter T,73 headed "Cooperatives and Their Patrons," is divided into these three parts: Part 1 Tax Treatment by Cooperatives; Part II —Tax Treatment by Patrons of Patronage Part III-Definitions; Special Rules. Subchapter T applies, in general, to “any corporation operating on a cooperative basis," with certain exceptions specified in section 1381(a)(2). Section 521 of the Code, while not a part of subchapter T, bears directly on the tax treatment of farmer cooperatives. Of course, a farmer cooperative is not required to qualify under section 521. If it does, though, in computing its taxable income under subchapter T it may use, in addition to all other deductions authorized by law, the deductions provided under section 1382(c) of the Code. These additional deductions, like those under the repealed section 522, relate to amounts paid during the taxable year as dividends on capital stock and certain nonpatronage income allocated to patrons such as rents received, investment income, gain on sale of capital assets, and income from business done with or for the U.S. Government. About 65 percent of the farmer cooperatives filing returns for the taxable year 1963 operated in compliance with the terms of section 521.74 Later unofficial statistics indicate an increase in the percentage of section 521 cooperatives to almost 70 percent of the farmer cooperatives filing returns. 75 Whether section 521 status is advisable for every cooperative where qualification is possible is a 7376 Stat. 1045-51, as amended in 1966 by Pub. L. 89-809, 80 Stat. 1580. 74Statistics of Income-1963, Supplemental Report, Farmers' Cooperative Income Tax Returns 1 (U.S. Treas. Dept. Int. Rev. Ser. Pub. No. 386, 1966). 75 Harmanson, Jr., The Cooperative Tax Picture, Cooperative Accountant, Winter 1968, 4 at p. 5; and Harmanson's report to the Annual Meeting of the National Council of Farmer Cooperatives, Washington, D.C., January 1969. Indications are that this percentage may decrease as the new "look through" principle is applied to federated cooperatives. See "Federated Cooperatives," p. 422; and Griffin, A Financial Profile of Farmer Cooperatives in the United States, FCS Res. Rpt. 23, Farmer Cooperative Service, U.S. Dept. Agr. (1972), p.65. 383 frequently debated question. Those wishing to pursue the subject will find that the pros and cons have been treated extensively.76 Requirements for 521 Status Section 521 of the Internal Revenue Code of 1954 provides as follows: §521. Exemption of Farmers' Cooperatives from Tax. (a) Exemption from tax. A farmers' cooperative organization described in (b) Applicable rules. (1) Exempt farmers' cooperatives. The farmers' cooperatives exempt from taxation to the extent provided in subsection (a) are farmers', fruit growers', or like associations organized and operated on a cooperative basis (A) for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (B) for the purpose of purchasing 76See, e.g., Guenzel, So-Called "Exempt" Cooperatives, American Cooperation-1970, 64; Magnuson, All Farmer Cooperatives And Other Corporations Operating On A Cooperative Basis, American Cooperation-1970, 69; McCullough, Cooperatives, Exempt or Non-Exempt-A 1970 Revisitation, Cooperative Accountant, Fall 1970, 2; McCullough, Cooperatives, Exempt or Nonexempt, American Cooperation-1968, 147; Olmsted, The Case for Nonexempt Status, Statement presented at 39th Annual Meeting, National Council of Farmer Cooperatives, January 1968; Marrs, Exempt Cooperatives-Why, American Cooperation-1968, 522; Nieman, “Exempt,” To Be Or Not To Be―The Case For, Cooperative Accountant, Winter 1962, 13; Olmsted, Cooperatives Should be Nonexempt, Cooperative Accountant, Winter 1962, 19. supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. (2) Organizations having capital stock. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 percent per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association. (3) Organizations maintaining reserve. Exemption shall not be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonable reserve for any necessary purpose. (4) Transactions with nonmembers. Exemption shall not be denied any such association which markets the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, or which purchases supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 percent of the value of all its purchases. (5) Business for the United States. Business done for the United States or any of its agencies shall be disregarded in determining the right to exemption under this section. 385 |