Credit Union and Cooperative Patronage Refunds - Filene ...

Figure 6: Potential Tax Effects of Patronage Refunds
27 Credit Unions as Exempt, Allocated 40% under Sub-T, and Allocated 100% Under Sub-T
Average of 2008, 2009, and 2010 501(c)(14) % Total Sub-T: 40% % Total Sub-T: 100% % Total
Cash patronage refund 822,800 23.34 282,076 8.0 822,800 23.34
Patronage refund in allocated equity — 0.00 1,128,304 32.0 2,703,149 76.66
Undivided/Unallocated earnings 2,703,149 76.66 1,184,719 33.6 — 0.00
Income tax on co-op’s earnings — 0.00 930,850 26.4 — 0.00
Total earnings (average per co-op) $3,525,949 100.00 $3,525,949 100.00 $3,525,949 100.00
Allocate and Distribute 100% of Patronage Refunds
Income tax is not owed under this Subchapter T scenario, because
we assume that all income is patronage sourced (generated from
transactions with members) and that all patronage income is allocated
to members on the basis of patronage. 31
The 27 credit unions in the Callahan study are already distributing
enough cash to qualify for tax treatment under Subchapter T. A minimum
of 20% cash refund is required by Subchapter T. These credit
unions paid 23.34%. Credit unions would prepare 1099-PATR
information returns, but we expect that many credit unions could
apply for and receive an exemption from reporting 1099-PATRs. 32
The bigger issue for these credit unions is whether they would be
able to redeem allocated equity, and whether there would be pressure
to redeem this equity. At the end of their first year operating under
Subchapter T, these credit unions would have allocated equity totaling
$2.7M dollars. If year two were identical, allocated equity would
total $5.4M at the end of that year. You can see how allocated equity
would quickly build up and grow from year to year. If these 27 credit
unions had been allocating earnings all along, each credit union
would, on average, have $54.0M of allocated equity as of December
31, 2011.
A 50-year equity redemption cycle, for example, applied to $54.0M
of allocated equity implies an annual equity redemption obligation
of $1.08M per credit union among the Callahan study credit unions.
Hence, these 27 credit unions would be expected to redeem more
than $1.20 of allocated equity for every $1.00 of patronage refunds
paid in cash, an objective that most likely is all but impossible for
these credit unions. So what would these credit unions do if they
operated under Subchapter T and were faced with that allocated
equity but could not redeem it?
These 27 credit unions would not redeem allocated equity unless
and until they had surplus working capital to allow redemptions of
equity. In fact, if the board of directors determined that the credit
52