Download Innovative Uses of Non

Innovative Uses of Non-Qualified Stock
Phil Kenkel
Bill Ftizwater Cooperative Chair
Sub-chapter T of the IRS tax code allows cooperatives which meet certain requirements to deduct
retained patronage (stock) distributions. These are called qualified distributions and are the traditional
stock distribution used by Oklahoma cooperatives. If the cooperative does not choose to deduct the
stock patronage it is a non-qualified distribution which is deductible to the cooperative and taxable to
the member in the year it is redeemed. The original argument for qualified distributions was that the
corporate tax rate was much higher than the producer’s tax rate so we didn’t want to “park” the tax
liability at the cooperative level for the period of time between issuing and redeeming the stock. If we
were establishing cooperatives today we would likely use non-qualified distributions because the tax
rate differential has shrunk.
At least one regional cooperative uses non-qualified stock in an innovative manner. CoBank uses a base
capital plan where a cooperative’s equity is related to their use of the bank (loan volume). Under a base
capital plan, equity does not revolve based age of stock but is rather returned when the member’s
equity percentage exceeds their usage percentage. CoBank also has goals for permanent equity in their
capital structure. As they increased permanent capital they made a decision to do so by issuing nonqualified stock rather than increase unallocated equity. The non-qualified stock is not involved in the
base capital plan so it is not intended to revolve. Since it doesn’t revolve the tax implications are
identical to retaining funds as unallocated reserves. The advantage of holding permanent capital as
non-qualified is that it is linked to a member. If the cooperative (in this case CoBank) was dissolved
there is clear ownership of the permanent capital. That is not true for unallocated reserves. Creating
permanent capital as non-qualified stock also eliminates the incentives for members to dissolve the
cooperative because their collective value (stock and unallocated reserves) far exceeds the value of their
stock.
A local cooperative would face more issues in using non-qualified stock as permanent capital. Unlike
cooperatives which have indefinite life, producers retire and eventually die. A local cooperative’s could
redeem non-qualified under an estate-only plan but it would have all of the planning disadvantages of
not systematically retiring the stock. Members might be less concerned about a longer redemption
period for non-qualified since they had not pre-paid the tax. Non-qualified stock could serve as more
permanent equity for a local cooperative, but not as true permanent capital. Still, semi-permanent nonqualified is one option to consider as we struggle to build and maintain strong balance sheets.
3-9-2012