It is misleading to call cooperatives that qualify under section 521 "tax exempt." The law in fact provides no income tax exemption for them. Unless this is understood, confusion will continue concerning the tax status of farmer cooperatives.

Unfortunately, the statute uses the heading "Exemption of farmers' cooperatives from tax" and otherwise refers to them as organizations "exempt from income taxes" while it subjects them to income tax under subchapter T. It is not surprising therefore that much of the material on section 521 cooperatives and the regulations themselves speak in terms of “exempt farmers' cooperatives" or "qualifying for exemption." But it seems a bit unrealistic to label as "tax exempt," cooperatives that pay substantial amounts annually in income taxes.77

A cooperative that qualifies under section 521 is referred to herein as a "section 521 cooperative" or one with "521 status" rather than a tax exempt organization. Occasionally, however, the words "tax exempt" and "exemption" will be found in quoted material or the text where it seems necessary to explain the holding of a revenue ruling or court decision.

If a cooperative can meet the requirements specified in section 521, it can qualify for the tax treatment provided in part I of subchapter T. The chief requirements for such qualification have been summarized as follows:78

1. It must be a farmer, fruit grower, or like association organized and operated on a cooperative basis to (a) market the products of members and other producers, or (b) purchase supplies and equipment for the use of members or other persons.

2. If organized on a capital stock basis, substantially all its stock (other than preferred nonvoting stock) must be owned by producers marketing products or purchasing supplies through it.

3. The dividend rate on capital shares must not exceed the legal rate of interest in the State of incorporation, or 8 percent a year, whichever is the greater, based upon the value of the consideration for which the capital shares were issued.

4. Financial reserves are restricted to those required by State laws or those that are reasonable and necessary, and must be

77See, e.g., Announcement 67-2, I.R.B. 1967-3, 21 (based on News Release IR-854, dated Dec. 15, 1966), reporting with respect to farmers' cooperative income tax returns that "exempt cooperatives paid $2 million in taxes for 1963, nonexempt cooperatives paid $13 million."

78 Farmer Cooperatives in the United States, FCS Bull. No. 1, p. 19, Farmer Cooperative Service, U.S. Dept. Agr., (1965).

allocated to patrons unless the cooperative includes them in computing taxable income.

5. Business with nonmembers may not exceed 50 percent of the cooperative's total business, and purchasing for persons who are neither members nor producers may not exceed 15 percent of the cooperative's total purchasing.

6. Nonmembers are to be treated the same as members in such business transactions as pricing, pooling, or payment of sales proceeds, in prices of supplies and equipment, in fees charged for services, or in the allocation of patronage refunds to the accounts of patrons.

7. Permanent records of the patronage and equity interest of all members and nonmembers must be maintained.

8. The legal structure of the organization must be cooperative in character and contain no provisions inconsistent with these requirements, and the association must be actually operated in the manner and for the purposes outlined in the requirements.

These eight requirements are discussed in more detail beginning on page 392.

Application for 521 Status and Tax Returns

In order to establish its section 521 status, every organization claiming that it qualifies must file a Treasury Department Form 1028. The Form 1028 should be executed in accordance with the instructions and filed with the District Director for the internal revenue district in which is located the principal place of business or principal office of the organization. Section 521 status is not automatic. 79

A ruling or determination letter will be issued in advance of operations of a farmer cooperative, provided it is shown that the cooperative is organized and will be operated for the purposes stated in section 521.80

79 Treas. Reg. § 1.521-1(a)(3)(e); Rev. Proc. 72-4, 1972-1 Cum. Bull. 706, and as to federated cooperatives, see also Rev. Proc. 72-16, 1972-1 Cum. Bull. 738, and Rev. Proc. 72-17, 1972-1 Cum. Bull. 739. See Announcement 70-13, I.R.B. 19705, 63, based on News Release IR-1010, dated January 29,1970, outlining a centralized procedure established by the Service for processing applications for "exemption," including 521 cooperatives, and for thorough audits of exempt organizations.

80 Rev. Proc. 72-4, 1972-1 Cum. Bull. 706.

387

The proposed operations must be described in sufficient detail to permit a conclusion that the cooperative clearly qualifies. A mere statement of a cooperative's purposes or a statement that proposed activities will be in furtherance of such purposes is not sufficient to satisfy the requirements for an advance ruling.

Complete evidence for each year for which qualification is sought should be furnished. For example, if a cooperative furnishes information and financial statements relating to one fiscal year, qualification, if in order, would be approved for that fiscal year and subsequent years. If, on the other hand, a cooperative furnishes the necessary information and statements for several prior years, qualification, if in order, would be recognized for the years for which complete evidence of qualification was furnished and subsequent years.

Cooperatives meeting the requirements of section 521 must file income tax returns, Form 990-C, on or before the 15th day of the 9th month following the close of their taxable year. The filing of Form 990-C appears to start the period of limitation under chapter 66 of the Code.

Farmer cooperatives not having 521 status file the usual corporation income tax returns (Form 1120). The due date of the Form 1120 return for such a cooperative is also the 15th day of the 9th month following the close of the fiscal year if the cooperative either (1) is under an obligation to pay patronage refunds of at least 50 percent of its "net earnings" from business done with or for its patrons, or (2) has actually paid patronage refunds in that percentage for the most recent taxable year it had such "net earnings."81 If a cooperative does not meet these standards, the due date of its income tax return (Form 1120) is the 15th day of the 3rd month following the close of the fiscal year.

Information Returns Required

The Revenue Act of 1962 requires certain tax information reporting by farmer cooperatives. Under this Act, all subchapter T cooperatives must file annual information returns on Forms 1096 and 1099 with the Internal Revenue Service reporting payments of interest, dividends, qualified written notices of allocation

81 Int. Rev. Code of 1954, § 6072(d)(2).

(patronage refunds), and redemption of nonqualified written notices of allocation of $10 or more a year to any one person.82

The 1966 per-unit retain amendments require a cooperative to include in these annual returns the face amount of qualified perunit retain certificates issued, as well as amounts paid in redemption of nonqualified certificates of $10 or more to any one person. Cooperatives also must send a statement to the recipient showing the amount reported to the Internal Revenue Service.

There is an exemption from some of these reporting requirements. If a cooperative is primarily engaged in retail selling of goods and services that are generally for nonbusiness use (personal, living, or family use), it may apply to the Secretary of the Treasury or his delegate for an exemption from the information reporting requirement.83

Audits and Revocation of Status

Once a ruling or determination letter is obtained, it is not necessary to refile for qualification unless substantial changes are made in the organization or its activities. An association is required, however, to furnish information annually on Treasury Form 990-C, which relates to its section 521 status.

The Internal Revenue Service is not precluded from making an investigation of such an organization to determine its eligibility or the amount of its tax liability.84

Qualification continues only so long as the legal setup and the operating methods are in accord with the requirements of the applicable statutes and regulations.85 Thus, a change in status can occur even though the letter of determination is not withdrawn, canceled, or revoked by the Internal Revenue Service.

82 Int. Rev. Code of 1954, § 6044 and the regulations thereunder. See also Rev. Rul. 68-236, 1968-1 Cum. Bull. 382.

83 Int. Rev. Code of 1954, § 6044(c).

84 United States v. Stiles, 56 F. Supp. 831 (W.D. Ark. 1944); Union Equity Cooperative Exchange, 58 T.C. 397 (1972). See also Announcement 70-13, I.R.B. 1970-5, 63, relating to audits, cited at footnote 79 in this section.

85 See Rev. Proc. 72-4, 1972-1 Cum. Bull. 706, for discussion of procedure in case of revocation or modification of determination letters and protests of adverse determinations. As to federated cooperatives, see also Rev. Proc. 72-16, 1972-1 Cum. Bull. 738, and Rev. Proc. 72-17, 1972-1 Cum. Bull. 739, relating to information from members and acceptable methods necessary to establish that operations satisfy the "look through" principle. See "Federated Cooperatives," p. 422.

In an early case it was held that if an association has been erroneously granted exemption, this ruling is not binding on subsequent Commissioners of Internal Revenue who may set the so-called exemption aside and then proceed to collect income taxes for the entire period in question.86 In the case cited, as no income tax returns had been filed, the statute of limitations had not run. It has also been held that the filing of Form 99087 would not start the running of the statute, because it was not a tax return and did not supply adequate information from which the amount of tax, if any, could be determined. 88 On the other hand, Form 990-C, which is the tax return section 521 farmer cooperatives must now file, would, however, be sufficient,89 and the filing of this form would start the running of the statute.90

Not only may an “exemption” which has been improperly allowed be set aside and the association be held liable for income taxes, but if the Service erroneously makes a refund to an association such refund may be recovered by the Government.91

86 Southern Maryland Agricultural Fair Association, 40 B.T.A. 549 (1939). See Lorain Avenue Clinic, 31 T.C. 141, 163 (1958); Southern Hardware Traffic Association v. United States, 411 F. 2d 563 (6th Cir. 1969), affirming 283 F. Supp. 1013 (W.D. Tenn. 1968), where the Commissioner was not estopped to correct a mistake of law and he was held not to have abused his discretion in revoking an exemption retroactively. See also Etter Grain Co. v. United States, 462 F.2d 259 (5th Cir. 1972), affirming 331 F. Supp. 283 (N.D. Tex. 1971); Union Equity Cooperative Exchange, 58 T.C. 397 (1972).

87 The information return required to be filed by certain "exempt" organizations after 1943.

88 Automobile Club of Michigan v. Commissioner, 353 U.S. 180 (1957). 89 In this connection, note that section 6501(g)(2) of the Internal Revenue Code provides that "If a taxpayer determines in good faith that it is an exempt organization and files a return as such under section 6033, and if such taxpayer is thereafter held to be a taxable organization for the taxable year for which the return is filed, such return shall be deemed the return of the organization for purposes of this section." California Thoroughbred Breeders Association, 47T.C. 335 (1966), holds that filing an information return (Form 990) constitutes the return for the purpose of the 3-year period of limitations against assessment of tax on unrelated business income imposed by section 511 of the Code. The Commissioner acquiesced in the result only (1969-1 Cum. Bull. 21), meaning acceptance of the decision of the court but disagreement with some or all the reasons assigned for the decision. See Rev. Rul. 69-247, 1969-1 Cum. Bull. 303. See also Colombo Club, Inc., 54 T.C. 100 (1970), holding that there was no abuse of discretion in retroactively revoking an exemption and that an application for exemption with supporting papers did not constitute the filing of a return within the meaning of section 6501(g)(2).

90 For applicable statute, see Int. Rev. Code of 1954, § 6501-6533.

91 Producers Creamery Co. v. United States, 55 F. 2d 104 (5th Cir. 1932).