Critical Issue: Unallocated Equity
Phil Kenkel
Bill Fitzwater Cooperative Chair
One of the more interesting financial issues identified by the cooperative expert panel was the
practice of retaining a portion of patronage based profits and unallocated equity. It is clear that
cooperatives need an adequate level of unallocated equity (retained earnings). It is also logical to
channel profits from non-member business to unallocated equity. Some cooperative leaders view
approaches to unallocated equity as a philosophy. A cooperative can decide to allocate as much of
its retained funds as possible or retain as much as possible in the form of unallocated equity. Other
experts view the excessive growth of unallocated equity as a violation of cooperative principles and
a loss of cooperative taxation advantages.
Members of a cooperative can receive benefit through favorable price, through cash patronage
refunds and through allocated retained patronage (stock refunds) when they are ultimately
redeemed. That can also be referred to as a customer role and an ownership role. Prices and cash
patronage impact members as customers while stock patronage impacts them as owners. The issue
with retaining patronage profits as unallocated equity is that it eliminates the ownership role. The
members collectively own the cooperative and their collective equity increases as earnings are
retained. However when an individual member retires or otherwise stops using the cooperative they
receive no benefit from the retained funds. Unless the cooperative is liquidated they benefit only
from a customer role and not an ownership role. This is the basic philosophical issue with excess
unallocated equity.
The other issue involving unallocated equity concerns taxation. Sub-chapter T of the IRS code
allows cooperatives to achieve pass through taxation on patronage source profits. Taxes are directly
passed through to the patron when the cooperative issues cash or qualified stock refunds.
Cooperatives pay taxes on profits issued in the form of non-qualified stock. However they get a tax
benefit when the stock is redeemed so the profits are ultimately taxed at member level. When
cooperative retains profits as unallocated equity the profits are taxed at the cooperative level. The
cooperative is in essence giving up the opportunity for pass through taxation.
There is a wide variation in strategies toward unallocated equity among cooperatives. There are
examples of successful cooperatives that allocate the maximum proportion of their retained equity
and other successful firms that lean heavily on building the unallocated portion of their balance
sheet. The appropriate balance of allocated and unallocated equity is an interesting philosophical
and strategic issue. What is your strategy?
9-14-2011