Is a Patronage Refund Considered Taxable Income?

A patronage refund is a distribution of a cooperative’s net earnings to its members, who are also known as patrons. This payment is a rebate based on how much business a member conducted with the cooperative, not a return on investment like a stock dividend. Cooperatives return earnings to users based on their patronage, allowing the organization to function “at cost.” This business model is common in sectors like agriculture, retail food, and financial institutions such as credit unions.

Determining the Taxability of Your Refund

The taxability of a patronage refund depends on whether the original purchases were for business or personal use. This distinction determines if the refund is considered income or simply a price adjustment.

Refunds from Business-Related Purchases

When a patronage refund stems from purchasing supplies or materials for a business, it is treated as taxable income. For example, if a farmer who is a member of an agricultural cooperative buys seed or fuel, those are deductible business expenses. The subsequent patronage refund lowers the cost of those expenses, and because the full expense was previously deducted, the refund must be reported as ordinary income to reflect the final cost.

Refunds from Capital Asset Purchases

The rule is different for refunds related to acquiring capital assets, such as a tractor or machinery for a business. In this case, the refund is not reported as immediate income. Instead, the refund amount reduces the cost basis of the asset, which is the value used to calculate depreciation and any gain or loss upon its sale. Reducing the basis means future depreciation deductions will be smaller and the taxable gain will be larger when the asset is sold.

Refunds from Personal Purchases

If a patronage refund is for purchases of personal, family, or living items, it is not taxable. Refunds from a retail food co-op on groceries or from a purchasing co-op for household supplies are viewed by the IRS as a price adjustment. Since the original purchases were made with after-tax dollars and not deducted as a business expense, the refund does not create income.

Understanding Your Form 1099-PATR

When a cooperative pays at least $10 in patronage dividends, it will issue a Form 1099-PATR, Taxable Distributions Received From Cooperatives, to the member and the IRS.

Box 1, Patronage Dividends, reports the total amount paid to you in cash, qualified written notices of allocation, and other property. Box 2 shows Nonpatronage Distributions, and Box 3 details Per-Unit Retain Allocations based on products you marketed through the cooperative. Box 5 is for the redemption of nonqualified notices from a prior year, representing deferred income.

Box 6 reports the Section 199A(g) deduction, a pass-through for patrons of certain agricultural or horticultural cooperatives, and Boxes 7, 8, and 9 may contain related information. If you do not receive an expected Form 1099-PATR, contact the cooperative to request a copy.

How to Report Patronage Income on Your Tax Return

The specific form you use to report taxable patronage income depends on the type of business activity. You do not need to attach Form 1099-PATR to your return, but you must include the taxable amounts in your income.

For individuals operating a farm as a sole proprietorship, taxable patronage dividends are reported on Schedule F (Form 1040), Profit or Loss From Farming. The amounts from Form 1099-PATR are entered on line 3a of Schedule F. Other sole proprietors or independent contractors report the taxable income on Schedule C (Form 1040), Profit or Loss from Business.

Qualified and Nonqualified Written Notices of Allocation

Cooperatives may pay a portion of patronage refunds through a “written notice of allocation,” which is a record of a patron’s share of retained earnings. The tax implications depend on whether the notices are “qualified” or “nonqualified.”

A qualified written notice of allocation requires the patron to have agreed to include its face value in their taxable income in the year it is received. For a notice to be qualified, at least 20% of the total patronage refund must be paid in cash. This allows the cooperative to deduct the notice’s full face value, while the patron pays tax on the entire refund immediately.

A nonqualified written notice of allocation is issued when the patron has not consented to immediate tax liability. The patron reports no income from the notice until it is redeemed for cash, sold, or otherwise disposed of. This method defers the tax burden for the patron until the funds are actually received.