Definition
Under IRC section 1388(a), a patronage dividend is an amount a cooperative pays to a patron based on the quantity or value of business done with the patron, under a pre-existing obligation, and determined by reference to net earnings from business with patrons. A dividend can be paid in cash, qualified written notices of allocation (retained equity), or other property. For a notice to be qualified under section 1388(c), at least 20% of the patronage dividend must be paid in money or by qualified check, and the patron must consent or have a right to redeem the notice in cash.
Why it matters in an audit or review
Patronage dividends can be deductible by the cooperative under Subchapter T. Auditors test the allocation method against bylaws, the cash and noncash split, and whether retained patronage is correctly reported in equity or, if redemption is required, as a liability. Patrons record the dividends in income or as a reduction of cost, depending on their own use of the purchases.
Example
Illustrative: a farm supply cooperative has $200,000 of net earnings from patron business and declares a qualified patronage dividend of that amount. At least $40,000 (20% of $200,000) must be paid in cash. The other $160,000 may be issued as retained equity allocations.
Common mistakes
- Allocating unequally to patrons for the same type of business.
- Mixing non-patron earnings into the pool.
Sources
- IRC section 1388, definitions and special rules: https://www.law.cornell.edu/uscode/text/26/1388
- IRC sections 1381 through 1388, Subchapter T, cooperatives and their patrons
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error