Choices in Retaining and Distributing Returns
Phil Kenkel
Bill Fitzwater Cooperative Chair
My cooperative class recently completed a homework assignment concerning a cooperative’s
choices in retaining and distributing returns. The topic is an interesting one and I would be tempted
to say that most managers and board members have never considered the full range of options. The
choices are inter-related but can be discussed in sequence. The first choice is how to distribute
earnings between dividends on stock, patronage refunds and unallocated equity. Agricultural
cooperative have not traditionally paid dividends on stock. However business models that combine
an investment return with a patronage return are receiving increased interest. A dividend rate on
stock would obviously make members less concerned about the revolving period. Bankers might
also like a structure with permanent preferred stock. Dividing income between unallocated reserves
and patronage raises a number of issues which I discussed in the “what is the right amount of
unallocated equity” article.
The second question is how to divide patronage refunds between cash and stock. If a qualified
stock distribution is being considered than the cash portion must be at least 20%. Most cooperatives
have concluded that 20% cash does not cover the member’s tax obligation on the stock portion. A
cash percentage of between 30%-50% are typical but the “right” level is for each board to decide.
The final question is whether to pay the stock portion in qualified or non-qualified stock. A
qualified stock is taxable to the members and tax deductible to the cooperative in the year issued.
Non-qualified stock is taxable to the member and deductible to the cooperative in the year
redeemed. A cooperative issuing non-qualified stock essentially “pre-pays” the tax on the earning
and then gets an offsetting deduction when they redeem the stock. Non-qualified is obviously more
popular with members because they are not paying tax on the stock portion until it is cashed in. Ag
cooperatives have traditionally focused on qualified stock. The gross domestic tax credit issue
(section 199) could increase the logic for non-qualified stock. It should also be noted that there is
no minimum cash percentage for non-qualified stock.
Two principles should be considered in determining the “right” choices for these decisions. First,
what will maximize the return to the member? Second, what will maintain the stability of the
cooperative? Once again, this is a balancing act for the cooperative manager and board. If your
board would be interested in a presentation on a cooperative’s choices in retaining and distributing
returns, let me know.
3-31-2011