PLR 200843023: Cooperative commodity checks were cash per-unit retain allocations

Plain-English summary

A nonexempt cooperative marketed a commodity for members and paid them through semimonthly checks plus year-end patronage dividends. The checks reflected the quantity delivered, arose under preexisting marketing agreements, were calculated without reference to the cooperative’s net earnings, and were paid within the statutory payment period. The IRS ruled that the checks were per-unit retain allocations paid in money under § 1382(b)(3), rather than purchases. For the cooperative’s § 199 domestic production deduction, qualified production activities income and taxable income were computed without the § 1382 deduction for those checks. The ruling also explained that inventory and cost-of-goods-sold adjustments must prevent a second deduction and that patrons could claim a passed-through § 199 amount only through the cooperative’s statutory designation process.

Ruling snapshot

• Question: Were the member checks cash per-unit retain allocations, and should the cooperative disregard their deduction when computing its § 199 deduction?
• Outcome: Approved. The checks qualified under § 1382(b)(3), and § 199 income was computed without their deduction.
• Key authorities: IRC §§ 199(d)(3), 1382, 1383, 1385, 1388(f); Treas. Reg. §§ 1.199-6, 1.1382-2, 1.1382-3

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 200843023 Third Party Communication: None
Release Date: 10/24/2008 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1382.00-00, 199.06-00 --------------------, ID No. -------------
Telephone Number:
---------------------
------------------------ Refer Reply To:
--------------------------------------------------------------- CC:PSI:5
---------- PLR-118751-08
------------------------- Date:
--------------------------- July 24, 2008

LEGEND

Coop = -------------------------

State = --------------

Year = -------

b = ----------------

c = ------

Dear -----------------

   This is in response to your request for rulings dated April 16, 2008, submitted by

your authorized representative. The rulings concern the interplay of the rules in
subchapter T of the Internal Revenue Code (concerning the taxation of cooperatives
and their patrons) and the calculation of the section 199 deduction for certain
cooperatives contained in section 199(d)(3).

      Coop is a nonexempt cooperative that is organized under the laws of State.

Coop markets the c of its b members. Coop has a December 31 year end. According
to the facts submitted, Coop enters into c marketing and membership agreements with
its members. The agreements may be one-year agreements, thirty- day agreements or
commodity pool agreements. The one-year agreement is the most common. After its
initial term, the one-year agreement is automatically renewable for one-year terms
PLR-118751-08 2

unless either party elects to terminate the agreement. The thirty-day agreement is
identical to the one-year agreement except that it has a thirty-day term and is
automatically renewable for thirty-day terms unless either party elects to terminate.
Members who enter into either of these agreements participate in Coop’s Value-Added
Pool. The third form of agreement is the commodity pool agreement.

   Under the terms of the one-year agreement (the Marketing Agreement), a

member agrees to produce and deliver to Coop all of the merchantable c produced at
the member’s facility or facilities listed in the Agreement. In the Marketing Agreement,
Coop agrees to receive the c, sell the same and account for the proceeds on a pool
basis. The member is required to warrant that all c delivered to Coop will comply with
all applicable laws and regulations and with the quality standards set by Coop.

   Coop’s practices for paying its members for c reflect the system that has existed

in the United States for many years. The market regulation of c is largely controlled by
the federal government. The federal government is authorized to regulate the
marketing of c by establishing federal marketing orders for c in the various regional c
markets. The purpose for the market order system for c is to develop a steady and
dependable market for c and to help correct conditions that result in price instability and
disorderly marketing of c.

   The market orders generally set the minimum price that must be paid by

handlers to c producers, however, cooperatives are not required to pay that price.
Cooperatives are free to determine how they share the net proceeds from the sale of
members’ c.

   At present, Coop distributes the net proceeds from the marketing of c in two

forms: 1) semi-monthly c checks and 2) patronage dividends paid after the close of the
year when net earnings for the year have been determined. Coop makes an advance to
producers for c delivered during the first 15 days of each month on or about the 25th of
the month. That advance is based upon what Coop anticipates paying for the c for the
month. However, Coop does not pay out the entire anticipated amount in the initial
advance, but rather pays out a high percentage, holding back the remainder in the case
the actual amount turns out to be less than anticipated. After the end of the month and
the market order price is determined, Coop determines what each member is to be paid
for c delivered during the month in the form of c checks and sends a second check to
the member for that amount. After the end of the year, b members receive a patronage
dividend paid out of the Coop’s net earnings for c delivered during the course of the
year.

   Coop believes that c checks should be classified as “per-unit retain allocations

paid in money,” not as “purchases.” Coop plans to begin reporting c checks in that
manner, starting with its Year tax return. For purposes of its section 199 computation
for Year, Coop intends to disregard c checks (as well as patronage dividends) and it
PLR-118751-08 3

plans to pass through to its members the portion of the section 199 deduction that Coop
will not be able to use.

   The following rulings are requested:

   1. The c checks that Coop pays to b members each year for c delivered to Coop

constitute “per-unit retain allocations paid in money” within the meaning of section
1382(b)(3) of the Code.

   2. For purposes of computing its section 199 domestic production deduction,

Coop’s qualified production activities income and taxable income should, pursuant to
section 199(d)(3)(C) of the Code, be computed without regard to any deduction for the c
checks.

   Section 1388(f) of the Code defines the term “per-unit retain allocation” to mean

“any allocation, by an organization to which Part I of this subchapter applies, to a patron
with respect to products marketed for him, the amount of which is fixed without
reference to net earnings of the organization pursuant to an agreement between the
organization and the patron.”

    Per-unit retain allocations (PURs) may be made in money, property or

certificates. Per-unit retain allocations paid in money and in property are excludable or
deductible under section 1382(b)(3) of the Code. Per-unit retain allocations paid in
certificates are deductible under section 1382(b)(3) if the certificates are qualified. If the
certificates are nonqualified, the cooperative is permitted a deduction under 1382(b)(4)
(or a tax benefit figured under section 1383) when the certificates are later redeemed.

    Section 1388(a)(1) of the Code provides that the term “patronage dividend”

means an amount paid to a patron by a cooperative on the basis of the quantity or value
of business done with or done for such patron. Section 1388(a)(2) provides that a
“patronage dividend” is an amount paid “under an obligation” that must have existed
before the cooperative received the amount so paid. Section 1388(a)(3) provides that
“patronage dividend” means an amount paid to a patron that is determined by reference
to the net earnings of the cooperative from business done with or for its patrons. That
section further provides that a “patronage dividend” does not include any amount paid to
a patron to the extent that such amount is out of earnings other than from business
done with or for patrons. Section 1.1382-3(c)(2) of the Income Tax Regulations states
that income derived from sources other than patronage means incidental income
derived from sources not directly related to the marketing, purchasing, or service
activities of the cooperative association.

   Section 1382(a) of the Code provides that except as provided in section 1382(b),

the gross income of any cooperative shall be determined without any adjustment (as a
reduction in gross receipts, an increase in cost of goods sold, or otherwise) by reason of
PLR-118751-08 4

any allocation or distribution to a patron out of net earnings or by reason of any amount
paid to a patron as per-unit retain allocations.

    Section 1382(b)(1) of the Code provides, in part, that in determining the taxable

income of a cooperative there shall not be taken into account amounts paid during the
payment period for the taxable year as patronage dividends to the extent paid in money,
qualified written notices of allocation, or other property with respect to patronage
occurring during such taxable year.

    Section 1.1382-2(b)(1) provides, in part, that there is allowed as a deduction from

the gross income of any cooperative to which part I of subchapter T applies, amounts
paid to patrons during the payment period for the taxable year as patronage dividends
with respect to patronage occurring during such taxable year, but only to the extent that
such amounts are paid in money, qualified written notices of allocation, or other property
(other than nonqualified written notices of allocation). Section 1388(d) of the Code
defines the term “nonqualified written notices of allocation” as meaning a written notice
of allocation other than a qualified written notice of allocation, or a qualified check that is
not cashed on or before the 90th day after the close of the payment period for the
taxable year for which the distribution of which it is part is paid.

  Section 1382(b)(3) of the Code provides, in part, that in determining the taxable

income of a cooperative there shall not be taken into account amounts paid during the
payment period for the taxable year as per-unit retain allocations paid in money, other
property, or qualified certificates with respect to marketing occurring during such taxable
year.

   Section 1382(e) of the Code provides that for purposes of section 1382(b), in the

case of a pooling arrangement for marketing products, the patronage shall be treated as
occurring during the taxable year the pool closes, and the marketing of products shall
be treated as occurring during any taxable years the pool is open.

   Though section 1382 of the Code is awkwardly drafted, the flush language of

section 1382(b) clarifies what it means for an item not to be “taken into account.” It
states that, “for purposes of this title,” a patronage dividend is treated as “an item of
gross income and as a deduction therefrom,” and a per-unit retain allocation in money
or qualified certificates are treated as a “deduction in arriving at gross income.”

   Section 1382(d) of the Code provides, in part, that the payment period for any

taxable year is the period beginning with the first day of such taxable year and ending
with the fifteenth day of the ninth month following the close of such year.

   Thus, per-unit retain allocations paid in money or qualified certificates are

deductions in arriving at gross income if paid with respect to an open pool within the
payment period for the taxable year. Because patronage dividends paid in money and
PLR-118751-08 5

qualified certificates are treated as deductions in arriving at gross income, Form 990-C
(and new form 1120-C) requires such dividends to be reported on Schedule H as a
deduction from gross income. Because per-unit retain allocations paid in money or
qualified certificates are treated as a “deduction in arriving at gross income” they are
reported on Schedule A of the Form 990-C which represents the cooperative’s cost of
goods sold. This does not change the fact that Coop is allowed a full deduction under
section 1382(b) of the Code for per-unit retains paid in money or qualified certificates.

   We note that to prevent a cooperative from deducting the per-unit retain

allocations made in money or qualified certificates for the second time when the
associated product is sold, the cost of goods sold mechanism associated with inventory
must be adjusted to reflect the deductions allowable under subchapter T. Specifically,
cooperatives need to include the PURs in inventory cost for purposes of making
inventory and section 263A of the Code computations and then adjust the ending
inventory and cost of goods sold to prevent double deduction of the PURs. The
adjustments can be made to either the inventory or the line item deduction for the
PURs. In other words, if the PURs are deducted on a deduction line in the
cooperative's tax return, they should be removed entirely from the ending inventory and
cost of goods sold computed for the tax year. Alternatively, if the PURs are not
deducted on a deduction line in the tax return, the PURs reflected in the ending
inventory should be removed and included in the cost of goods sold amount for that tax
year. This procedure will allow the cooperative to deduct the PURs once while also
preserving the integrity of its section 263A calculation.

    Under section 199(d)(3) of the Code, patrons that receive a qualified payment

from a specified agricultural and horticultural cooperative are allowed a deduction for an
amount allocable to their portion of the qualified production activities income (QPAI) of
the organization received as a qualified patronage dividend or per-unit retain allocation
which is paid in qualified per-unit retain certificates. In particular, section 199(d)(3)(F)
requires the cooperative to be engaged in the manufacturing, production, growth, or
extracted (MPGE) in whole or significant part of any agricultural or horticultural product,
or in the marketing of agricultural or horticultural products. Under section 199(d)(3)(D),
in the case of a cooperative engaged in the marketing agricultural and horticultural
products, the cooperative is treated as having MPGE in whole or significant part any
qualifying production property marketed by the cooperative that its patrons have MPGE
(this is known in the industry as the “cooperative attribution rule”). In addition, section
199(d)(3)(A)(ii) requires the cooperative to designate the patron’s portion of the income
allocable to the QPAI of the organization in a written notice mailed by the cooperative to
its patrons no later than the 15th day of the ninth month following the close of the tax
year.

  Under section 1.199-6(c), for purposes of determining a cooperative’s section

199 deduction, the cooperative’s QPAI and taxable income are computed without taking
PLR-118751-08 6

into account any deduction allowable under section 1382(b) or (c) of the Code (relating
to patronage dividends, per-unit retain allocations, and nonpatronage distributions).

   An agricultural or horticultural cooperative is permitted to “pass-through” to its

patrons all or any portion of its section 199 deduction for the year provided it does so in
the manner and within the time limits set by section 199(d)(3) of the Code. When a
cooperative passes-through all or any portion of the section 199 deduction, the
cooperative remains entitled to claim the entire section 199 deduction on its return
(provided that it does not create or increase a patronage tax loss), but is required under
section 199(d)(3)(B) to reduce the deduction or exclusion it would otherwise claim under
section 1382(b) for per-unit retain allocations and patronage dividends.

   Section 1.199-6(l) provides: “No double counting. A qualified payment received

by a patron of a cooperative is not taken into account by the patron for purposes of
section 199.”

   Section 1.199-6(e) defines the term qualified payment to mean any amount of a

patronage dividend or per-unit retain allocation, as described in section 1385(a)(1) or (3)
of the Code received by the patron from a cooperative, that is attributable to the portion
of the cooperative’s QPAI, for which the cooperative is allowed a section 199 deduction.
For this purpose, patronage dividends and per-unit retain allocations include any
advances on patronage and per-unit retains paid in money during the taxable year.

  Section 1.199-6(k) provides that the final regulations are the exclusive method for

the cooperative and its patrons to compute the amount of the section 199 deduction.

    The effect of these sections is that the cooperative will compute the entire section

199 deduction at the cooperative level and that none of the distributions whether
patronage dividends or per-unit retain allocations received from the cooperative will be
eligible for section 199 in the patron’s hands. That is, the patron may not count the
qualified payment he receives from the cooperative in his own section 199 computation
whether or not the cooperative keeps or passes through the section 199 deduction.
Accordingly, the only way that a patron can claim a section 199 deduction for a qualified
payment received from a cooperative is for the cooperative to pass-through the section
199 amount in accordance with the provisions of 199(d)(3) of the Code and the
regulations thereunder.

   Coop’s c checks qualify as per-unit retain allocations within the meaning of

section 1388(f) of the Code because they were distributed with respect to c that Coop
markets for its patrons, and by the fact that the patrons receive the payments based on
the quantity of c delivered; the c checks are determined without reference to the Coop’s
net earnings; the c checks were paid pursuant to a contract with the patrons
establishing the necessary pre-existing agreement and obligation; and the c checks
were paid within the payment period of section 1382(d).
PLR-118751-08 7

  Based on the foregoing, we rule as requested that::

   (1) The c checks that Coop pays to b members each year for c delivered to Coop

constitute “per-unit retain allocations paid in money” within the meaning of section
1382(b)(3) of the Code.

    (2) In computing Coop’s section 199 domestic production deduction, Coop’s

qualified production activities income and taxable income should, pursuant to section
199(d)(3)(C) of the Code, be computed without regard to any deduction for the c
checks.

   This ruling is directed only to the taxpayer that requested it. Under section

6110(k)(3) of the Code it may not be used or cited as precedent. In accordance with a
power of attorney filed with the request, a copy of the ruling is being sent to your
authorized representative.

                                        Sincerely yours,

                                        Paul F. Handleman

                                        Paul F. Handleman
                                        Chief, Branch 5
                                        Office of the Associate Chief Counsel
                                        (Passthroughs & Special Industries)

cc:
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