By Phil Kenkel, Vice Chair, Cooperatives CoP and Bill Fitzwater Cooperative Chair, Oklahoma State University, email@example.com.
In a recent national project, academic researchers, cooperative managers and members, USDA, agricultural foundations and other stakeholders collaborated to identify the critical issues facing agricultural cooperatives. A two-stage Delphi survey was conducted, followed by expert panel sessions in Washington, D.C. and Minneapolis, Minnesota. The material below summarizes some of the findings from the project.
Unallocated equity, also called unallocated reserves and retained earnings, is permanent equity capital that is not assigned to a specific member’s account. Over 80 percent of the cooperative leaders surveyed considered the implication of unallocated equity an important issue, although it did not receive the extremely important rankings of some of the other financial issues. It is clear that cooperatives need an adequate level of unallocated equity. This category of equity serves as a cushion fund and prevents the need to write down the value of member stock in every instance where the cooperative experiences a loss. It is also logical to channel profits from non-member business to unallocated equity. The controversy with unallocated equity occurs when a cooperative channels a portion of member-derived profits into unallocated equity and/or when the unallocated equity category becomes a substantial part of the cooperative’s total equity.
Some cooperative leaders view approaches to unallocated equity as a philosophy. These experts would maintain that a cooperative can decide to allocate as much or as little of its retained funds as it desires 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. This structure can also be referred to as a customer role and an ownership role. Prices and cash patronage impact members in their customer role. Stock patronage impacts them in their ownership role. 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 cooperatives retains profits as unallocated equit,y the profits are taxed at the cooperative level. The cooperative is in essence giving up the opportunity for pass-through taxation.