Per-Unit Capital Retains and Patronage Refunds for Farmers

A per-unit capital retain is a fixed amount that a marketing cooperative holds back from what it owes a farmer for each unit of product sold through the co-op, such as a bushel, a hundredweight of milk or a percentage of the sale value. The co-op records the held-back money as the farmer's investment in the co-op and repays it later. A patronage refund is different: it is the farmer's share of the co-op's year-end net earnings. USDA describes the per-unit retain as a second patronage-based financing tool, "an important source of capital for certain marketing cooperatives."

This page explains both, how the IRS and the tax code treat them, what "qualified" and "nonqualified" mean, and how revolving cycles repay the money. It reports what IRS Publication 225, subchapter T of the Internal Revenue Code and USDA Rural Development reports say. It is not tax advice. Each co-op's bylaws and marketing agreement decide what applies to you, so ask the co-op for its own rules.

Per-unit retain or patronage refund: the difference

IRS Publication 225, the Farmer's Tax Guide, explains where each shows up for a farmer. If you buy farm supplies through a cooperative, you may receive patronage dividends (refunds). If you sell your farm products through a cooperative, you may receive either patronage dividends or a per-unit retain certificate. The cooperative reports the income on Form 1099-PATR or a similar form.

The tax-code definitions are in 26 U.S.C. 1388. A patronage dividend is an amount paid to a patron on the basis of the quantity or value of business done with or for the patron, under a pre-existing obligation to pay it, and determined by reference to the co-op's net earnings from business with patrons. A per-unit retain allocation is any allocation by a co-op to a patron "with respect to products marketed for him, the amount of which is fixed without reference to the net earnings of the organization pursuant to an agreement between the organization and the patron." A per-unit retain certificate is the written notice that shows the stated dollar amount of that allocation.

Because a per-unit retain does not depend on earnings, USDA says it gives a co-op "the ability to raise equity in years with low earnings or even losses." The same report adds that it also gives the co-op "the flexibility to make per-unit retain allocations before the end of the fiscal year." See patronage refunds for the earnings-based side.

How a per-unit retain works, step by step

USDA's Cooperative Information Report 44, Part 3 describes a typical transaction:

1. The agreement. A co-op's authority to issue per-unit retains usually appears in its bylaws, the member marketing agreement, or both.
2. The sale. The co-op markets a patron's product and the sale produces a price per unit.
3. The deduction. Under the marketing agreement, the co-op deducts a fixed amount of money per unit from the check it sends the patron for sales proceeds, treated as the patron's equity or debt interest in the co-op.
4. The certificate. The patron receives a per-unit retain certificate showing the interest. The certificate's stated value is the amount invested in the co-op.
5. The use. The co-op can use the money to replenish working capital, for general capitalization, or as a reserve for a special purpose.
6. The repayment. Co-ops often use funds from newer retains to redeem certificates issued earlier. USDA says this "enables a cooperative to revolve capital accounts so that patron investment is more nearly related to current patronage or use."

USDA's Cooperative Information Report 56, Managing Your Cooperative's Equity, adds that the retain can be set on a physical unit of product delivered or on a percentage of the sales value of the commodity, that marketing cooperatives are the predominant users, and that the retain can be raised or lowered to offset changes in volume or price. For dairy, the same report says per-unit retains are usually deducted from each month's milk check, which gives the co-op a steady source of equity through the year.

Two ways to set the amount

A worked example (illustrative numbers)

The figures below are made up to show the arithmetic. They are not a real co-op's numbers.

Suppose a grain marketing co-op deducts a retain of $0.05 per bushel under its marketing agreement, and a member delivers 10,000 bushels in each of four years. Each year the member's retain is 10,000 x $0.05 = $500, and the member receives a per-unit retain certificate for $500. Suppose the board's policy is to revolve each year's retains after three more years of retains have been collected.

At the end of Year 4 the member's account holds $1,500: the retains from Years 2, 3 and 4. In Year 5, the Year 2 retain would be repaid. The repayment timing is a board decision, so the cycle could be longer or shorter than three years, and a co-op can pause it if cash is tight.

Qualified and nonqualified retains

Under the tax code, a co-op gets its tax deduction for a per-unit retain, and the farmer reports the income, according to whether the certificate is "qualified." The statute (26 U.S.C. 1388(h) and (i)) and IRS Publication 225 describe the two kinds.

How a patron agrees. Under 26 U.S.C. 1388(h)(2) and IRS Publication 225, the agreement can be made in writing, or by getting or keeping membership in a co-op whose bylaws or charter state that membership counts as agreement. In that second case the co-op must notify the patron in writing and give a copy of the bylaw.

What the IRS says about qualified certificates. Publication 225: "Qualified per-unit retain certificates are those issued to patrons who have agreed to include the stated dollar amount of these certificates in income in the year of receipt." A farmer who receives them includes the stated dollar amount in income on Schedule F for the year of receipt.

What the IRS says about nonqualified certificates. Publication 225: "Don't include the stated dollar value of a nonqualified per-unit retain certificate in income when you receive it. Your basis in the certificate is zero. You must include in income any amount you receive from its sale, redemption, or other disposition." The amount is reported as ordinary income on Schedule F for the year of disposition.

The co-op's side. Under 26 U.S.C. 1382(b), a co-op's taxable income does not take into account per-unit retain allocations paid during the payment period in money, qualified certificates or other property, or money or property paid to redeem a nonqualified certificate. Publication 225 summarizes the result for farmers: per-unit retain certificates "generally receive the same tax treatment as patronage dividends."

A difference from patronage refunds. USDA's Report 44, Part 3 notes that a qualified patronage refund must have at least 20 percent paid in cash or by qualified check (26 U.S.C. 1388(c)(1)), while a per-unit retain issued as a qualified certificate "doesn't require that some portion of the allocation be paid in money."

If you are deciding whether to sign a consent or how to report a certificate, ask a tax professional. Publication 225 is written for farmers, and your co-op's year-end Form 1099-PATR shows what it reported.

Revolving cycles: how retains are paid back

A per-unit retain is an investment that comes back only when the board decides to redeem it. USDA's Equity Redemption Guide (Cooperative Information Report 31, dated April 1983 and approved for reprinting in 1991) describes the methods co-ops use. USDA Research Report 220, a 2008 survey published in 2010, lists five major methods: revolving fund, patron's estate, patron's age, percent of all equities, and base capital.

CIR 56 calls revolving fund programs the most common type of systematic redemption. It says the board may set a target revolving period and tries to hold to it "as long as financial conditions allow."

Two points from USDA that matter to a farmer:

• The board decides. USDA says redemption decisions are made by the board of directors after it determines that the co-op's financial condition warrants the action. CIR 31 adds that courts are usually reluctant to substitute their judgment for the board's, though in a few cases a member has used a court to force a board to redeem equity, usually where the board failed to balance the interests of current and former members or violated a bylaw, the articles of incorporation or a state statute.
• The length of the cycle varies. USDA's 2008 survey (Research Report 220) found that revolving fund length remained long, "especially for grain and oilseed and farm supply cooperatives whose revolving fund length averages at least 18 years." Each co-op's own period is in its bylaws and policies.

The revolving cycle is also why retained equity belongs in your plans as locked-up money. For the broader picture of how co-ops fund themselves, see cooperative capital.

Questions to ask a co-op about retains

These are questions, not advice. Every co-op answers for itself.

1. What is the retain? Ask whether it is a dollar amount per unit or a percent of sales value, and where it is written (bylaws, marketing agreement).
2. Is the certificate qualified or nonqualified? And what consent does the co-op treat as given when you join?
3. What is the redemption policy? Ask for the revolving period target, what years are being redeemed now, and any special redemption for estates or age.
4. How do I see my equity? Ask for an annual statement of your equity account by year.
5. Is the retain also used with a patronage refund? USDA notes co-ops with marketing operations may use both.
6. What happens to my equity if I stop delivering? Ask the co-op for its redemption policy for former members.

Frequently Asked Questions

What is a per-unit capital retain?

It is a fixed amount a marketing cooperative deducts from a farmer's sales proceeds for each unit sold, or as a percent of sales value. The co-op treats it as the farmer's investment, gives the farmer a per-unit retain certificate, and repays it later under its redemption policy.

How is a per-unit retain different from a patronage refund?

A per-unit retain is fixed by agreement without reference to the co-op's net earnings, so it can be collected even in a low-earning year. A patronage refund is the patron's share of the co-op's net earnings from business done with patrons. The 26 U.S.C. 1388 definitions say exactly this.

Is a per-unit retain taxable?

Per IRS Publication 225, a qualified per-unit retain certificate's stated dollar amount is included in income in the year received. A nonqualified certificate is not income when received, has a basis of zero, and is income when sold or redeemed. Ask a tax professional about your own return.

What is a qualified per-unit retain certificate?

It is one issued to a patron who has agreed to include its stated dollar amount in income in the year of receipt. The agreement can be in writing or by getting or keeping membership in a co-op whose bylaws say membership counts as agreement and that notified the patron in writing.

When do I get my per-unit retains back?

When the co-op's board redeems them. Many co-ops use a revolving fund, repaying the oldest year first, but the board sets the timing based on the co-op's finances. Ask the co-op for its redemption policy.

Do all farm co-ops use per-unit retains?

No. USDA's CIR 56 says marketing cooperatives are the predominant users, and a co-op may use a retain in place of retained patronage refunds or in addition to them. A co-op's bylaws or marketing agreement show what it uses.

Does a dairy co-op use per-unit retains?

USDA's CIR 56 says dairy marketing co-ops usually deduct per-unit retains from each month's milk check. Check your own co-op's milk statement for the deduction. See dairy cooperatives.

Can a co-op pay a per-unit retain in cash?

Yes. USDA's Report 44, Part 3 says per-unit retains can be paid in money, certificates or other property, and that cash per-unit retains are mostly used by co-ops that pool member products and close the pool after the end of the tax year.

Where to go next

• Patronage refunds
• Cooperative capital
• Agricultural cooperatives: the full guide
• How to join a farm cooperative
• Farm Credit System
• Dairy cooperatives
• Marketing cooperatives
• Cooperative taxation
• The Capper-Volstead Act