Could a cooperative use expenses from member or nonprofit nonmember business, beyond the related income, to offset taxable profit from nonmember business?

Plain-English summary

California Legal Ruling 289 held that a cooperative could not use expenses associated with member or nonprofit nonmember business, beyond the related income, to reduce taxable profit from business conducted with nonmembers for profit.

The ruling treated the special deduction for member and nonprofit nonmember income as already accounting for that class of business. Deducting the same business's expenses again would produce a double deduction.

The historical statutes were intended to relieve qualifying cooperative income from tax while preserving tax on profit-making nonmember business.

The two income classes

The ruling read former sections 24404 and 24405 as creating different treatment for:

1. income from business with members and nonprofit business with nonmembers; and
2. income from profit-making business with nonmembers.

The first class was relieved from taxation. The second class remained taxable.

The cooperative position rejected

Cooperatives contended that they could deduct:

• all operating expenses; and
• all gross income from member business and nonprofit nonmember business under former sections 24404 and 24405.

That approach would leave a loss equal to the expenses of the cooperative business even though its gross income had already been deducted. The loss could then offset profit-making nonmember income.

FTB rejected that result because it would effectively deduct the same economic item twice and substantially or completely shelter income the Legislature intended to tax.

Role of former section 24425

The ruling said the same result followed even if sections 24404 and 24405 were assumed to permit a deduction for the entire gross income from member and nonprofit business.

Former section 24425 disallowed an otherwise available deduction when the amount was allocable to a class of income excluded from the measure of the Bank and Corporation Tax Law.

Expenses producing the relieved class of cooperative income therefore could not also create a net loss used against taxable nonmember profit.

What this means for you

Cooperatives

The historical ruling required cooperatives with both relieved and taxable activities to keep the two classes economically separate. Expenses of relieved business could not be shifted to profit-making nonmember business.

Cooperative managers

Track whether transactions are with members or nonmembers and whether nonmember activity is conducted at cost or for profit. Those distinctions drove the ruling's tax treatment.

Accountants and tax professionals

Allocate income and expenses consistently. A special exclusion or deduction for one class of income generally does not support a second deduction for the same costs against another taxable class without statutory authority.

Common questions

Q: Could excess expenses from member business offset nonmember profit?

A: No, not under the historical ruling.

Q: How was nonprofit nonmember business treated?

A: It was grouped with member business as the class the historical statutes intended to relieve from tax.

Q: What nonmember income remained taxable?

A: Income from business conducted with nonmembers on a profit basis.

Q: Why did FTB call the cooperative approach a double deduction?

A: The approach would deduct the qualifying gross income and then use all expenses incurred to produce that same income to create a loss against taxable business.

Q: Did section 24425 independently support the result?

A: Yes. The ruling said it barred deductions allocable to income classes not included in the tax measure.

Citations and references

• Former Cal. Rev. & Tax. Code §§ 24404, 24405, and 24425

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 289

Original ruling text

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Legal Ruling 1965-289

California Franchise Tax Board
Legal Ruling No. 289

April 23, 1965

Cooperative: Deduction of Excess Expenses

The facts are, briefly, that cooperatives contend in determining their net income that they may deduct all operating expenses and also, with respect to business done with members and done with nonmembers on a nonprofit basis, are entitled to a deduction of the gross income under Sections 24404 and 24405 of the Bank and Corporation Tax Law.

For the purpose of computing the taxable income of cooperatives should the expenses incurred in producing member and nonprofit income, to the extent the expenses exceed such income, be used to offset income from business done with nonmembers for profit?

The theory that a cooperative is entitled to deduct from its gross income all its gross income from business activities with members or from nonprofit business activities with nonmembers plus all the expenses incurred in earning that gross income is completely at variance with the established principle of construing the deduction provisions of an income tax law so as to preclude the deduction twice of the same item. Furthermore, as might be expected from this rule against double deductions, that treatment clearly would defeat the legislative intent as to the taxation of cooperatives.

It is clearly apparent from a reading of Sections 24404 and 24405 that they provide different treatment for two classes of income, namely:

income from business activities with members and from nonprofit business activities with nonmembers, and

income from business activities on a profit basis with nonmembers.

It is equally apparent that the Legislature desired to relieve from taxation the first class of income but to apply the tax with respect to the second class of income.

The Board’s method of treating cooperatives achieves this legislative objective in all respects. In fact, only by so treating a cooperative having both classes of income may that objective be attained.

Under a contrary position cooperatives would always have a loss from their cooperative business in the amount that expenses were incurred in carrying on that business, and this loss would substantially, if not entirely, offset income from profit-making activities, which should be taxable.

Even if it were assumed that the deduction permitted by Sections 24404 and 24405 is the entire gross income from member and nonprofit business, the cooperative would not be entitled to also deduct a net loss incurred in producing that income. Section 24425 provides that in computing net income no deduction shall be allowed for any amount otherwise allowable as a deduction which is allowable to one or more classes of income not included in the measure of the tax imposed by the Bank and Corporation Tax Law. Application of this section in computing the net income of a cooperative will lead to the same result as is reached under the Board’s method.

Last updated: 09/24/2025