Calculating a Cash Neural Percentage of Non-Qualified Stock
Phil Kenkel
Bill Fitzwater Cooperative Chair
Under Sub-Chapter T of the IRS code cooperatives have two options for issuing retained allocated patronage (stock) referred to as qualified and non-qualified distributions. Traditionally, grain and farm supply cooperatives have distributed qualified stock which is excluded from the cooperative’s income and taxable to the member in the year it is issued. Qualified stock is a logical choice when the patron’s tax rate is much lower than the cooperative’s. Under those conditions a non-qualified distribution effectively overpays the IRS in taxes which is corrected only when the stock is redeemed and the cooperative gets the tax deduction.
In today’s environment the tax rates for the cooperative business and the patrons are very similar. This is leading more cooperatives to consider issuing non-qualified stock. Distributing profits in a combination of cash and non-qualified stock is obviously attractive to the patron because they are taxed only on the cash portion. The patron might also be in a lower tax bracket at the time that the stock is redeemed. The cooperative receives a tax deduction at the time of redemption which decreases the effective redemption budget. The obvious challenge (unless the cooperative can offset the taxes with the Section 199 credit) is that the cooperative’s current cash flow is reduced since it must pay taxes on the retained profits.
A cooperative can manage the cash flow impacts of non-qualified stock by reducing cash patronage. Boards and managers are often confused as to how to calculate a distribution of cash and non-qualified stock which is cash neutral relative to a given distribution of cash and qualified stock. Consider a cooperative with $100 in net savings which is currently distributing 40% cash and 60% stock and has a 25% tax rate. At first glance one would guess that the cash patronage must be reduced from $40 to $25 to make up for the $15 tax deduction (25% of $60) that the cooperative received on the qualified stock. However the cash patronage that is being reduced is also deductible. The cooperative must actually reduce the cash patronage by $15 divided by (1-tax rate) or $20 ($15 divided by .75) in order for the change to be cash neutral. If the patron is also in the 25% tax rate the change is also cash neutral for the patron. If a patron (or sub-group of patrons) are in a lower tax bracket relative to the cooperative then the change will reduce their cash flow in the current year.
The switch from qualified to non-qualified distribution presents a communication challenge. The cooperative must help the patron understand that while their rate of cash patronage may be reduced their tax obligation is also delayed until the stock is redeemed. I have developed a spreadsheet calculator that determines the cash neutral non-qualified distribution for a given distribution of cash and qualified stock. It also illustrates the impact on the patron under any selected tax rate. Email me at if you would like a copy.
9-5-2012