The Cooperative Balancing Act – Patronage v. Equity

• October 30, 2023
• Kelly Jackson Hardy

As we conclude National Cooperative Month and enter the heart of board meeting season for cooperatives in the Midwest, I wanted to take a minute to discuss a topic of much interest on both the cooperative and producer sides of the table – patronage.

One of the biggest debates within ag cooperatives is the use of patronage and the balancing act between patron relations, income taxes, and equity management. Patronage can be seen as a marketing tool or a way to avoid income taxes. On the flip side, it can be seen as a strategic concept used to manage equity, current ownership, and the betterment of the facilities to which the producer has access. Some cooperatives pay based on what the maximum amount allowable is, others pay a fixed percentage of income each year, others a flat amount per bushel or in total.

There is nothing wrong with any of the approaches if they do not damage the cooperative from the inside. Often, the answer is to declare as much as possible to pay the least amount of income taxes at the cooperative level. While this sounds like a good idea on the surface, it does not always produce favorable results. To qualify for a tax deduction, the patronage paid in cash must be at least 20% of the total allocation, which generally isn’t enough to cover the income taxes on the total allocation (cash and stock). A coop needs to pay closer to a minimum of 40% cash to cover the tax obligation and more if they want the producer to put some cash in their pocket. With tools such as DPAD/Section 199A(g), cooperatives can build working capital quickly by using the DPAD deduction to offset income for tax purposes and not rely on large patronage allocations to reduce income taxes. Depreciation methods are still favorable with bonus depreciation still available for 80% of the purchase price and Section 179 100% write-off is still an option if total fixed asset acquisitions are less than $2.89 million. The question is not really how much patronage to pay, but how much equity does the cooperative want to or can afford to give up in order to pay patronage. The marketing, income tax, capital investment and equity management factors mentioned above all have to be considered and balanced.

We encourage boards to look at long term patronage strategy and not to just look at patronage a year at a time. When interest was cheap, it may well have been easier to just borrow from the bank to finance projects and operations. Obviously, interest rates have changed and the cost of capital improvements have not gone down in price either. What kind of facility improvements could you use that cash for? Working capital is getting tighter both on the farm and at the elevator. This may not be the year to pay the “most”.

But what if the cooperative had a great year and management and the board wants to reward current members? Nonqualified allocations can provide a good option in this scenario and leave the cooperatives working capital intact. Nonqualified allocations do not qualify for a tax deduction until paid out but do put a name on the income and can provide a future cash benefit to a member when paid. From the producer’s perspective they add to their stock allocations on the cooperative balance sheet.

The cooperative model’s principals provide that the entity is not just for the benefit of the members of today but also for the members of tomorrow. The goal of the entity is to survive into perpetuity. Whether you’re reading this post as a producer, a board member or a member of your local cooperatives management, consider these factors as you discuss patronage this year. Balance your goals and determine what is most important to the long-term success of the cooperative.

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