We're getting close but need to make a foundational decision before the deal can be done - we have to make a choice about what kind of entity this cooperative is going to be. Shall we be Cooperative Corporation or Cooperative Partnership LLC? (See the Co-op Law's description of these two types of entities.) Each has pros and cons, and each has implications for the fundamental underpinnings of the business.
In order to help us make the decision, we got in touch with Bruce Mayer at Wegner CPAs. Like the expert that he is in cooperative accounting, he broke it down for us. Generously, he's allowing us to share his explanations and commentary here. Thanks, Bruce! I've categorized it here according to various partnership versus corporation considerations for your reading pleasure:
(Everything below in italics are Bruce's words.)
BUILDING RESERVES ...partnership rules are not conducive to building up reserves that belong to the Co-op. All income passes through to the owners’ personal returns. So any funds you want to leave in the Co-op to help it continue after the current owners leave will need some accounting and agreements that don’t work well in a partnership. Basically people need to leave behind funds that they paid tax on. In contrast, corporate taxation allows a decision to be made each year about what part of profits goes to owners by patronage dividends or is taxed to the Co-op and stays as retained earnings.
INDIVIDUAL TAXES In partnership taxation all owners have compensation reported on the K-1 and they need to pay quarterly estimated taxes. In a corporation owners get a W-2 unless you set it up as a clearinghouse or service type of Co-op and then folks would get a 1099-MISC. When there are K-1s for a large group there will be pressure to get the tax return done quickly. People will want to file their 1040s. For corporate taxation the completion of the return and the decision to allocate the profit or loss can wait since it does not change owner taxes in the year just passed.
TIMING and TAX RETURN DEFERRAL In partnership taxation the profit or loss is allocated to owners in the same year the Co-op has the loss or profit. In corporate taxation any profit allocated by a patronage dividend is deducted by the Co-op in the year earned but it is income to the individuals in the year the patronage dividend is allocated. So if there is a 2016 profit and the amounts are paid out as patronage dividends in 2017, the Co-op deducts it in 2016 while the owners claim it as income in 2017. There is a one year deferral of the tax on that amount.
RETAINED EARNINGS from NON-MEMBERS When there is work done by non-owners any profits generated by that will be allocated to owners in partnership taxation. In corporate taxation that amount stays with the Co-op which pays the tax and keeps it as retained earnings.
ALLOCATION OF LOSS In partnership taxation the loss is immediately allocated to the owners for the year of the loss. In corporate taxation you have the choice of allocating the loss to members or letting the Co-op keep the loss to offset past or future income. In partnership taxation all income is allocated to owners. In corporate taxation there is a choice about allocating that to owners or having the Co-op pay tax on it.
DIRECTIONALITY It is possible to try partnership accounting and then in a later year switch to taxation as a corporation. You cannot go in the other direction. Once corporate taxation is chosen the only way to get back to partnership taxation is to dissolve and start over.
dojo4 is likely going to go with being a Cooperative Partnership LLC for now. We need to get ourselves over the finish line and that route is easiest for us at this point, since we are already a partnership. It will allow us to have the least amount of administrative and accounting overhead in the short-term. And when/if we're ready, we can move to being a Cooperative Corporation. Our venerable lawyer, Jason Wiener, (who also, wisely, recommended Wegner/Bruce to us) assured me that both forms are bono fide versions of being a cooperative organize- phewsh! Almost there...
see the next installment in the series, blog #4