Are cooperative patronage dividends subject to employment tax?

Guest post by Gregory Wilson, Esq.

Over the past few years, IRS Examination (audit function) undertook correspondence “audits” of several members of worker cooperatives asserting the position that the member’s patronage dividends are subject to self-employment (SE) tax. Attorney Greg Wilson fought these cases asserting that patronage dividends were not subject to SE tax for various reasons. Eventually, an attorney for the IRS – IRS Counsel’s Office – in San Francisco, asked the IRS National Office for guidance on this issue. It appears that the IRS National Office concluded that patronage dividends paid by worker cooperatives are indeed not subject to SE tax and dropped the cases where it was asserting SE tax applied to worker coop patronage. But the IRS arrived at this conclusion because they determined the worker/members are employees of the cooperative and employees generally cannot receive both employment and self-employment compensation from the same entity. Continuing with this theme, the IRS then hinted that its position might be that patronage dividends paid by worker coops should be subject to employment taxes at the cooperative level – instead of SE tax – like a bonus paid to an employee. Where the IRS is going with this now is unclear.

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3 Responses to Are cooperative patronage dividends subject to employment tax?

  1. Dmitriy Kustov, CPA July 6, 2009 at 11:39 am #

    Hopefully, the IRS will have a tough time arguing for the bonus treatment. Patronage dividends are similar to ownership draws in an S corporation setting. Because every member of a coop has strictly one share one vote, the profit participation is measured by the amount of business with of the member with the coop. Bonuses, on the other hand, are usually given based on special achievements (increased profits, discovery, commissions for new accounts, etc.), not simply on hours worked. It’s a good news, though, that they dropped the member side challenge.

  2. Lori Matthews September 22, 2009 at 6:20 am #

    I was a worker/owner of a cooperative that declared patronage dividends for 2008. I’ve just received a letter indicating that they are reporting the dividends to the IRS and issuing a 1099-DIV form to me at the end of this year. However, they are not going to pay the dividends until a future date, currently undecided by the board. Is this legal? Can they report dividends they aren’t paying, and if so, must I pay taxes prior to receiving the dividends? Thank you.

  3. Jenny Kassan September 22, 2009 at 12:45 pm #

    Yes, the co-op is actually required to report these allocations to the IRS and you are required to pay tax on them! If this is creating a hardship for the members of the co-op, you may want to discuss as an organization what percentage of patronage income should be paid out in cash versus allocations.

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